Invoice factoring is a form of accessing funds where a business converts any outstanding invoice that is due within a 90-day period. It can be likened to accounts receivable financing which is paid in two installments.
The first installment which is an advance typically ranges from 70 to 90 percent while the balance is received after the outstanding invoice is fully settled. It is a financing option available to government agencies and businesses that invoice other businesses.
Invoice Factoring versus Invoice Financing
Although both terms are used interchangeably, invoice financing does not require the assignment of invoices and is more streamlined and easy to use. Invoice factoring, on the other hand, deals with short-term solutions for B2B companies that have cash flow problems. Invoice factoring simplifies the cash flow conversion of a business which means it is typically not used for big capital investments.
How Invoice Factoring Works
When a B2B or B2G transaction takes place, an invoice is issued for payment. The invoice generated must be payable within a 90-day period to qualify for factoring. This is the first eligibility criteria to be met before a business is considered fit enough to receive financing. Once your business is considered okay, due diligence will be conducted on the customers you invoice to determine whether they are a good credit risk.
The invoice factoring company you apply to in order to sell your outstanding invoices will sign an agreement that includes the initial amount you can borrow if they approve your application. You are then advanced the money which is typically about 70 to 90 percent of the invoice transaction size.
This may be followed by a ‘notice of assignment’ to the customer whose invoice you factored. In some cases, you may be asked to do so. This means payment will be received by the company that factored your invoice. Following the complete payment of the invoice factored, the balance is now paid by the company factoring the invoice.
Before the balance is paid, factoring fees will be deducted first.
How To Qualify For Invoice Factoring
The three major things that Factors care for are:
1. The need to invoice another business or the government and not an individual customer. The customer you invoice also needs to be an established one with good credit scores. This is important for the factor who wants to be assured of the likelihood to pay off an invoice.
2. The invoice has to be due or payable within the space of 90 days and not pledged as collateral.
3. Your business should be free of tax or legal problems.
These are basic things which business owners should know about invoice factoring.