What is invoice factoring?
Finance for recruitment agencies

What is invoice factoring?

Factoring (or invoice factoring) is a type of short-term business finance or cash flow finance option in which a company's accounts receivable ledger is sold to a third party (or a factor) in exchange for instant capital. The factor then takes on responsibility for credit control and collection of the debt. In this article, we'll look in detail at the world of factoring.

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What is invoice factoring?

Invoice factoring is a way for businesses to get cash quickly and easily. Invoice factoring is a type of invoice finance where you sell your company's outstanding invoices to a third party in exchange for immediate payment. The factoring company will then collect payment directly from your customers. In Australia, the meaning of invoice factoring is the same as in the UK and US.

Factors can be banks or independent finance companies. Factoring facilities tend to have long lock-in contracts, usually 24 months, and typically all invoices must be sold as part of the arrangement. The factor is responsible for credit checking customers, chasing payments and dealing with a business' client base on behalf of that business.

It provides businesses with quick working capital allowing them to continue trading. They can pay staff, cover operating costs, expand, and meet their order demand.

How does factoring invoices work?

Factoring invoices is a process that allows companies to sell their invoices to a business or financial institution, which will then collect the money due and pay the company the net amount.

The most common way to do this is for a company to sell its receivables (i.e., invoices) to a factor. A factor buys a customer’s receivables, paying most (but not all) of the outstanding amount. The factor then collects on those receivables, paying the seller the rest of the total invoices – minus their fee.

For example, let’s say you have a customer who owes you $1,000. You sell them to a factor for 90% of that amount, or $900. The factor collects the debt from your customer and pays you the remaining $100 minus their fee.

Invoice factoring vs line of credit

Invoice factoring is often known by various names, including accounts receivable financing, invoice financing or debtor finance. These terms, however, technically describe the broader category of which factoring is only a specific type.

A line of credit is essentially an unsecured loan from a bank or other financial institution. You can use it to fund daily operations or cover expenses until you receive payment on outstanding invoices.

The main difference between invoice factoring and a line of credit is that invoice factoring allows you to access cash quickly while your customers pay off their invoices over time. With a line of credit, you can draw down on funds as needed but will have to repay them through regular payments over time.

Factoring and invoice discounting

An alternative to invoice factoring is invoice discounting. It is similar and offers many of the benefits of factoring, such as instant working capital, no fixed asset requirements, relatively quick and easy application process. Still, it comes with one main difference: you stay in control. If you're currently using an invoice factoring company, it might be helpful to compare it with invoice discounting services.

Invoice discounting is a form of invoice finance, which means that the invoice discounting provider gives the business an advance against its invoices. The advance is based on the creditworthiness of your business and your customer's ability to pay their invoices. Invoice discounting payments are made when you receive payment from your customer, which can be as soon as one day after they pay their invoice.

Invoice discounting companies remain in the background of your day-to-day operations. Debtors will often pay into a bank account the discounting company has set up for you. Collections and customer relationships still remain your responsibility.

Invoice factoring can be more expensive than invoice discounting. In many cases, you'll spend less upfront if you choose another option, such as an overdraft or line of credit (LOC). You might also consider selling invoices on your own without involving any third parties, but this can be time-consuming and difficult unless you have experience with it already or have access to someone who does.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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