Alternative financing might be new to you and seem less appealing than traditional financing.
Through education, we can easily set aside many of the stigmas associated with alternative finance. But, with the right partner, businesses can often benefit more from factoring than traditional financing. Many business leaders are surprised to learn that alternative finance can frequently help them access traditional financing.
Before discussing this, however, knowing more about Invoice Factoring and its history is essential.
Key Takeaways
- Invoice factoring has roots in ancient Mesopotamia and the Roman Empire. It later developed through Italian grain trade and maritime commerce. It gained modern prominence post-2008 financial crisis.
- Businesses sell outstanding invoices to a factoring company for immediate cash. The factor advances most of the invoice value and releases the remainder after customer payment, minus fees.
- Ideal for businesses needing quick cash flow, especially those unable to secure traditional financing. Requires outstanding receivables to qualify.
- You can access funds within a week, but the timing of reserve release varies by factor. Express Business Funding provides same-day reserve releases upon customer payment.
- EBF offers advisory services, acting as an extension of leadership to improve business processes.
- Provides liquidity and financial flexibility for small business owners without the delays of extended payment terms.
What is Invoice Factoring?
Invoice Factoring is a financing solution in which you, as a business owner, can sell your accounts receivable (your unpaid invoices) to a third party, known as a factor, at a discount. This allows your company to receive immediate cash flow instead of waiting for your customers to pay their invoices, which can take 30 to 90 days or more.
Express Business Funding doesn’t just provide factoring to your business; we also make ourselves available to assist in transforming your business processes. By offering advice, insight and hands-on guidance, you can use factoring not only for its intended purpose but, in many cases, to improve your bottom line. This is not an industry standard, but something we believe is an essential part of our service.
The History of Invoice Factoring
While it may seem novel initially, Invoice Factoring is almost as old as commerce. Cash flow availability has been a stumbling block for business leaders throughout history. Surprisingly, Invoice Factoring can trace its roots back to ancient Mesopotamia and the Roman Empire.
The first true use of invoice factoring, however, was conducted in Italy, where grain farmers would factor their harvests to gain funds before the end of the crop cycle. Three hundred years later, the East India Trading Company and other maritime traders used it to provide capital to farmers, hunters, and other suppliers of goods to Europe from the Americas and vice versa.
Factoring has experienced an increase in demand from business leaders of all sizes because it has become more accessible, in tandem with the strict policies of traditional financing facilities, after the 1970s.
How Does Invoice Factoring Work?
- Selling Invoices: When a business completes a sale and issues an invoice for its goods and services, it can choose to sell their invoice to a factoring company. The factoring company will typically pay a percentage of the invoice upfront, which is often around 70% to 98%.
- Receiving Immediate Working Capital: Once the factoring company purchases the invoice, the business immediately receives the agreed-upon percentage of the invoice amount. This influx of cash can be crucial for maintaining operations, paying employees and investing in growth.
- Collection Process: The factoring company is responsible for collecting payment from the customer. They will follow up with the customer to ensure the invoice is paid on time.
- Final Payment: Once the invoice is paid, the factoring company releases the remaining balance to the business minus their fees. The fees vary and is often based on the agreement. Typically, it will be a percentage of the invoice amount.
The Benefits of Invoice Factoring
- Improve Cash Flow: Businesses get access to capital quickly, which can help them manage expenses and plan for their business through investment opportunities without waiting for customer payments.
- No Added Debt: Unlike business loans, invoice factoring does not create debt on your balance sheet as it is a sale of your assets rather than a lending arrangement.
- Flexible Financing: Companies utilize invoice factoring as needed, which allows them to improve their bottom line based on current cash flow requirements.
- Focuses on Growth: With some factoring company handling collections, business owners can focus on their core operations and growth rather than chasing customers for payments.
- Some factoring companies value further discretion and allow you to better maintain your customer relationships by limiting notifications and allowing businesses to continue internal collections.
How would you know if Invoice Factoring is right for you?
Invoice factoring is not an out-of-the-box solution, which means it won’t be the best financing option for every business owner. When your business needs fast working capital, and traditional financing isn’t enough to extend your line of credit, invoice factoring is likely the best solution for you.
One of Invoice Factoring’s greatest advantages is the speed with which it can be made available to a business. Generally, factoring is made accessible within a week of application, however invoice factoring can only be rendered when you have outstanding accounts receivables, so while it may meet your need for quick liquidity, you may not be eligible.
Depending on which factor you opt to work with, the reserve value of the invoice/s factored should be availed to you within 24 hours of receipt of payment from your customer. At EBF, when all documentation is in order, reserves are released on the same day payment of the outstanding invoice/s is received. This may not always be the case, however.
Some factors transfer the reserves from paid receivables to a business within 7/ 14/ 30 days from the date of payment. It is critical that you check these terms when engaging a factor, as these unnecessarily long payment cycles will accrue interest (even after your customer has settled their account and the factor has received payment)!
Factoring is also affordable. While terms may differ from factor to factor, the fees owed when invoices are factored are generally around 1.5% – 2.5% per thirty days factored. This, as above, is factor-dependant though. Ensure that you engage with a reputable factor to avoid incurring hefty, unwarranted costs. These costs can and should be reduced to a minimum by utilizing your factoring facility in the way it was designed. For expert advise on our to execute this, feel free to reach out to us and we’ll set you on the right path.
If your business is reliant on the timely payment of a complete or partially complete project to commence with another project, factoring will work well for you. Many construction, staffing, manufacturing, and small-to-medium sized businesses, for example, require payment from previous contracts to begin working on their next project, and in this instance, factoring is the best option for their business. This alleviates the overall impact of what we call the “cash-flow crunch”.
Many businesses operating in new industries also suffer from credit shortfalls, as traditional lenders typically avoid unchartered ground. By working with a factor, new businesses can receive the aid that they need to achieve high growth.
Finally, factoring assists un-bankable businesses. When a business does not meet the (often stringent) criteria of a traditional credit provider, or have been referred to the bank’s special loans department, it can feel like the end of the road. Alternative financiers assess the risk of the credit line offered in a very different way to traditional financers, and as such, is much more accessible.
If you would like to find out more about Invoice Factoring, we welcome you to contact one of our expert Account Managers. We would love to identify how we can help you!
