It is helpful to revisit the fundamentals of invoice factoring periodically. We frequently refer to the invoice factoring procedure in many blogs, but often when concentrating on the benefits of accounts receivable financing as it relates to a specific topic. We have recently discussed the documentation and process involved, but let’s illustrate a little further.
When you decide to factor your company’s accounts receivables, you are essentially selling them to a factor at a discount in exchange for a cash advance. The factor must wait normally 30 but up to 90 days to collect the full value of the invoice from your customers.The discounted invoice amount is the factor’s fee for advancing cash on unpaid invoices. This amount may also be referred to as a rate.
There are three parties involved in the factoring process:
The factoring client provides goods or services for which there is an issued invoice
The client’s debtor pays the invoice under specified terms
The invoice factoring company speeds up the process by purchasing the invoice from the factoring client for cash, thereby financing the amount over a period agreed upon by the factor and the client
A factoring illustration (figures are simplified)
- The factor purchases an invoice worth $10,000 from the factoring client under the factoring contract.
- The factoring client receives 80% of the value of the invoice (in this example)
- The remaining 20% is received once the invoice has been paid by the debtor; minus a discount fee (2% in this example) This 20% serves as a reserve amount and is held by the factor until payment has been received from the debtor.
- According to this illustration, once the factor agreement is in place, the factor advances $8,000 to the factoring client, and acquires ownership of the full amount of the accounts receivable.
- The invoice is paid 30 days later, and $1,800 is released to the factoring client. 20% minus the factoring discount fee
The reserve (percentage of the invoice advanced) can be anywhere from 10 – 30% of the value of the invoice, and is assessed, similar to the discount fee, according to the perceived risk of late or non payment, also on the payment history of the debtor, and length of terms that have been agreed upon. These terms, and any fees will be explained by the factor when the factoring client enters into an agreement.
The cash flow, and general financial health of your company is extremely dependent upon your short-term assets. Make sure you utilize cash flow best practices. Invoice factoring can greatly help keep short-term assets moving, but make sure you choose your factoring company wisely. Understand all the fees presented by your factor, and go over the agreement closely.
At Bay View Funding, we have been providing comprehensive factoring services to businesses - in a wide range of industries - for more than three decades. Whether you need funds for payroll or working capital to expand your business, we can help provide the best factoring solution to meet the unique and specific needs for your company.