In a typical business situation, a company makes a sale, creates an invoice and sends it to the customer. Factoring can be more costly than other kinds of financing, but many companies like the assurance it provides that they'll obtain needed cash quickly.
The approach is most often used by startups and growing companies that are trying to act quickly and may not want to go through the conventional bank loan application process. Invoice factoring is a way to cushion some of the effects of delayed payments and the cash flow problems they may create. This situation can become almost as perilous as if the company's entire business is unprofitable. If a company has customers with extended payment terms it can make it difficult for them to meet their financial obligations. But profitability doesn't always equate to positive cash flow. Most companies need to be profitable to stay in business - i.e., their revenues must exceed their expenses.
Invoice financing is similar to invoice factoring in that it's a way for businesses to get paid quickly on an invoice, rather than having to wait weeks or months before payment is officially due. Invoice factoring and invoice financing are two types of accounts receivable financing.
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Once the factoring company receives full payment of the invoice, they pay the balance of what is owed to the seller, keeping a percentage of the total invoice amount as revenue. In most factoring situations, the factor becomes responsible for collecting on the invoice. In return, the business receives the majority of the invoice amount - as much as 90% - within a few business days, rather than having to wait the 30-, 60- or 90-day period specified on the invoice. With invoicing factoring, a business sells any number of unpaid invoices to a factor for less than the amount it is owed. For a small company, factoring often provides faster access to cash than bank financing because factors are less likely to be deterred by a small company's credit history. Typically used by small and medium-sized businesses (SMB) in business-to-business (B2B) industries, the process involves sell of unpaid invoices to a third party, known as a factor or factoring company, which retains a percentage of the original invoice amount. Invoice factoring is one way to smooth out cash flow challenges. In other cases, consequences can be as dire as a company going out of business because it can't pay its debts. In some cases, poor cash flow may mean missing out on an opportunity to grow the business. Yet it's the rare business that isn't occasionally affected by slow or uneven cash flows. East, Nordics and Other Regions (opens in new tab)Ĭash flow is the lifeblood of growing businesses, essential for covering costs in every area of their operations.
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