Ask many people about invoice factoring and chances are they will not be able to tell you how it works. Truth is, factoring is a simple answer to increasing cash flow but is still somewhat of a secret, and more companies should be aware of the benefits of factoring their invoices to improve cash flow.
So why is it a secret? It is simply not the first option that springs to mind when looking for cash to grow your business or pay bills. A bank loan or a revolving line of credit will often be considered first. These traditional forms of financing not only take a while to set up with the bank, but also show up as negative amounts on your balance sheet. You may also be surprised to learn how many large publicly held businesses choose to factor their accounts receivable.
Back to that cash flow secret! Let’s briefly summarize the concept of factoring.
- You approach a factor to sell your outstanding invoice for cash
- The factor checks the credit of your customer
- Once the creditworthiness of your customer is established, your factor advances the majority of the invoice to you
- The factor collects the money from your customer
- The bill is paid directly to the factor
- The balance of the invoice is paid to you by the factor minus a factoring fee
Once you decide to use a factoring company, you can generally get paid on your invoices within 24-48 hours. You can quickly increase your cash flow without having to take out a loan and increase your debt. An added benefit of factoring is that the factor handles the billing and collections for you, saving you time and money.
Here’s another part of the secret: Many factors are also industry specialists, in fields such as trucking or construction. They understand the market and the needs of their customers. In these instances, they are able to quickly assess the risk and factor the invoices accordingly.