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Invoice factoring

Factoring also known as debtor financing and receivables factoring that is commonly used for domestic trade financing as well as international trade finance. Factoring is a process using which a business can sell to a financial institution the value of invoice for which it has not received payment yet, for obtaining the cash it needs right away. The business is supposed to sell the value of the accounts receivable (generally due within 90 days) to the financial institution (which is commonly referred to as the “factor”) at a certain discount, creating the opportunity for the factor to access profit. The discount given is usually between 10 to 20 percent.

Notably, factoring can be chosen as recourse or can be chosen as non-recourse. A factoring which includes recourse means that the factor can seek compensation from the business if the accounts receivable are not paid fully. Conversely, if it does not include recourse, the factor has to bear the loss without compensation from the business.

The process

Receivable factoring is a form of business finance which begins when your business provides products to thee creditworthy customers. After completion of service i.e. shipping goods, your business would follow the steps below:

  • 01
    The supplier sells the products to the buyer and raises the invoice on customer.
  • 02
    The seller is then supposed to submit the invoice for funding to the factor. The factor then verifies the invoice.
  • 03
    After verification, the factor pays 80 to 90 percent to the customer who sells the account receivables.
  • 04
    The factor then has to wait till the customer makes the payment to him.
  • 05
    After receiving the payment from the seller, the factor pays the desired amount to the client.
  • 06
    A fee is charged by the factor in terms of interest i.e. in advance or it may be in arrears. It totally depends upon the type of factoring that has been chosen and included within the agreement.

Key points

  • It is simple to approve funding process
  • Provide payment terms for customers
  • Smoother cash flow in terms to aid financial planning
  • Eliminate bad debt risk and overhead costs
  • There are no financial covenants

Advantages of invoice factoring

  • check_circle_outlineIt helps to reduce the credit risk for the seller.
  • check_circle_outlineThe working capital cycle can run smoothly because the factor immediately provides funds over the invoice.
  • check_circle_outlineSales ledger is maintained by the factor which leads to a reduction of cost.
  • check_circle_outlineHelps to improve liquidity and cash flow within the organization.
  • check_circle_outlineIt provides the seller with cash in hand. This helps the business in paying its creditors in a timely manner.
  • check_circle_outlineIt minimizes the need for the introduction of new capital for the business.
  • check_circle_outlineThere is a saving of collection cost.

Example

To understand this more specifically let us go through an example. If the accounts receivable have value US$100,000, the business can sell them to the factor for almost US$80,000. In this situation the business is willing to forgo 20 percent of the accounts receivable value in order for obtaining US$80,000 today to keep the business running, instead of US$100,000 some months in the future. The factor buys the generated and promised value of these accounts receivable for only US$80,000 but have to wait for few months for receiving that full value, which includes a gross profit of US$20,000.

In this type of purchase, accounts receivable are discounted in order for allowing the buyer to make a profit over the settlement of the debt. Moreover, factoring results in transferring the ownership of accounts to other party that then chases up for the debt. Factoring thus relieves the main party of a debt for less than the total amount providing them with working capital to continue trading, while the factor or we can say the buyer of account receivables, chases up the debt for the full amount and gets profit when it is paid.

It is seen as a very common method which is used by exporters for accelerating their cash flow. The process enables the exporter to certainly draw up to 80% of the sales invoice’s value at the point of delivery of the goods and when the sales invoice is raised.

Want more information about invoice factoring? or looking for most suitable finance solution for you? Talk to our finance experts now.

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