Invoice Factoring

What Is Invoice Factoring?

Invoice factoring allows businesses to sell their invoices to a factoring company (also known as a factor) at a discounted rate for access to immediate cash. Invoice factor rates vary but are typically between 1% and 5%. Although the invoices are typically unpaid, the company is confident they will be paid, but the lengthy payment process of 30, 45 and even 60 days is impacting their cash flow. Invoice factoring is one financial solution to this problem.

How Does Invoice Factoring Work?

Invoice factoring involves many of the same steps as invoice financing:

Step 1) An apparel supplier company sells its unpaid invoices to an invoice factoring company, for a percentage of the value of the invoices.

Step 2) The factoring company immediately advances a percentage of the invoice’s value, often within 24 to 48 hours.

Step 3) The apparel supplier’s customers pay the factoring company directly. The factoring company is responsible for collections.

Step 4) The factoring company pays the apparel supplier the payment of the invoices after taking its fee and any interest.

An Example of Invoice Factoring

Let’s say that the apparel supplier above has three outstanding invoices worth $100,000 with payment terms of 30 days, but needs immediate cash to cover operational expenses. Until customers pay, it’s short on cash flow, so it resorts to factoring.

A factoring company agrees to advance 80% of the invoice value ($80,000) and charges a 3% factoring fee ($3,000). The apparel supplier receives $80,000 upfront, while the factoring company takes responsibility for collecting the invoice payment from the customer.

When the customers pay the invoices in full, the factoring Company deducts its 3% fee ($3,000) and remits the remaining balance of $17,000 to the business.

What action is taken?

Apparel supplier receives 80% of the $100K value of its outstanding invoices

Factoring company receives invoice collection from customers

Factoring company returns loan from financial company + fees + interest

What the apparel company nets from the order of $100K *

$97,000

Cash Flow

+ $80,000

+$100,000

$17,000

N/A

* The business ends up paying $3,000 for an immediate cash flow of $100K.

The Pros and Cons of Invoice Factoring

Is factoring worth the fees that are withdrawn from your invoice payments? That depends on the financial status of your business and your cash flow needs. Although there are additional benefits to factoring, there are also several disadvantages to consider.

Pros:

Improved cash flow: Many businesses have recurring cash flow problems; fast and easy access to capital can be crucial to staying afloat, such as sudden investment opportunities.
Flexible financing: Factoring uses the value of outstanding invoices to receive cash, as opposed to traditional loans which require collateral. This opens up more financing opportunities for businesses that might not qualify for traditional loans.
Reduced collection efforts: The business is not responsible for invoice collections, which is often a cumbersome manual process. Factoring companies help save them this burden that would otherwise cost them time and resources.

Cons:

It’s more suited to businesses with many customers. Factoring is a more risky financial endeavor compared to other invoice financing options. Spreading the risk among many customers allows organizations to lower their overall risk.
Higher costs: Although fees range, most factoring companies take into consideration the risk of late payment. If they are collecting invoices from less established customers, they may charge higher fees.
May negatively impact customer relationships: Potentially aggressive collection methods concern companies because they may lead to customer attrition or publicized complaints.
Limited control: Once you sell an invoice to a factoring company, businesses have limited control over the collection process and the handling of potential disputes.

Is Invoice Factoring Right For Your Business?

For many companies, especially those with long payment cycles, invoice factoring can be a welcome relief from slower cash inflows and the burden of invoice collection. However, there are several points organizations must keep in mind. First, regardless of how much a company scales, invoice factoring always requires an organization to give up a percentage of their revenue as a fee to the factoring company. For large companies, this may translate to a loss of millions of dollars. Second, as a company grows, it can be far more cost-effective to have in-house collections teams. In-house A/R collections teams also allow an organization more control over the collections process and the opportunity to facilitate better relationships with customers.

How Gaviti Can Accelerate Your Cash Flow

Although it has its benefits, invoice factoring can be a risky and aggressive collection method for improving cash flow. It can require your company to pay a significant amount of that hard-earned cash flow to the factoring company. Since it transfers the debt collection process to an outsourced company, it can also impact your business relationships. Gaviti’s accounts receivable management platform streamlines and optimizes your invoicing and collections processes so you can get paid 30% to 50% faster. Our customized workflows and payment portal automates this process so that you can reduce the need for invoice factoring while remaining in control of the collections process to better enhance customer relationships.

Want to learn more about how to automate the receivables collections process and improve your cash flow?

Speak to a Specialist today to see how Gaviti works.