The invoice factoring method is used when a business factors its account receivables to meet its immediate liquidity needs. Banks, fintech startups, and other financial institutions are the main factoring companies in South Africa. A factor is regarded as a funding source that pays a company the discounted value of its invoices.
What is Invoice Factoring?
Invoice Factoring is a method of funding a company’s cash flow through the sale of the company’s invoices to a factoring company. A factoring company provides funding to a company in terms of liquid cash and in turn, receives invoices to cash in when they are due.
The factoring company buys the invoices at cost less fees and commissions. Discount for commissions is the interest that a factoring company charges for providing funds to a company.
The factoring company is responsible for the collection of invoices that are due. Invoice factoring funding can be between 60% – 95% of the invoice value sold and 40% – 5% of the invoice value contributed to commissions and fees.
Characteristics of Invoice Factoring
- A company sells its invoices to a factoring company in exchange for funds.
- Invoices sold are sold at a discount and fees are also discounted.
- A factoring company sets the terms and conditions of the invoice factoring contract, therefore, terms and conditions vary per factoring company.
- Invoice factoring is a way for companies to acquire cash flow from invoices that are not yet due at a premium.
- The factoring company is responsible for the collection of invoices due.
How Invoice Factoring Works
Businesses have accounts receivables and these accounts can sometimes take longer to settle. Selling goods and services on credit poses a liquidity problem in a company. Issued invoices normally have a due date and can sometimes have a repayment term of up to 90 days.
In some cases with the South African government, payment can take up to 120 days to settle. However, companies will still need to continue doing business even when the company’s cash flow is compromised. Companies can opt to get liquid through invoice financing.
With invoice financing, a company can choose invoice factoring as a method of funding. A company using Invoice factoring will sell its invoices in part or in total to a factoring company, depending on its cash flow needs.
A factoring company will buy invoices before they are due from a company selling its invoices at a discount for commissions and fees. The factoring company buys the invoices at 60% – 95% of the invoice value.
Customers of the borrowing company pay the factoring company directly. The factoring company is then responsible for the collection of invoices that are due.
The factoring company pays the company that sold its invoices to the remaining invoice amount. However, the payment will be done when the invoices are paid in full.
When to use Invoice Factoring
When a company has a large number of outstanding invoices and its cash inflow is suffering as a result, it should use Invoice factoring. This lending option will help the company cope with liquidity so that it can meet its short-term obligations.
A factoring company will do the collection of accounts receivables and do the chasing of debtors that do not pay on time. This will assist the borrowing company in savings on administration fees that would have been incurred to collect the debt.
Invoice factoring funds do not come with any restrictions of use and the money is only added to the company’s working capital. The money can be used for anything. Therefore, if the company wants to buy an asset or meet its short-term obligations it can sell its invoices to a factoring company.
Invoice factoring is a great solution for companies with poor credit ratings. Factoring companies mostly look at the creditworthiness of debtors when issuing invoice financing.
Advantages of Invoice Factoring
- Invoice factoring eliminates the need for debt collection. Staff members can work on the company’s core operations without worrying about the company’s debtors.
- Interest for invoice factoring is not as high when compared to other types of loans.
- Financing is based on the company’s customers’ creditworthiness, therefore, a company with a bad credit rating can get funding from a factoring company.
- Money acquired from the factoring company doesn’t have any use restrictions, therefore, a company can use the money to do anything it wants.
- It provides cash flow upfront and working capital expands.
- A company is able to reduce its business overhead immediately instead of waiting for invoices to be paid. This helps all business functions to work accordingly.
Disadvantages of Invoice Factoring
- Factoring companies prefer companies with a handful of customers as they want to spread their risk as widely as possible.
- If a company has unreliable customers, the factoring company will charge it high fees because of the risk associated with the company’s customers.
- Relationships with customers can be jeopardized by the factoring company if they pursue the debt in an aggressive way.
- A factoring company may require a company to only use its factoring services in the future.
Invoice Factoring can help any company with liquidity issues that have invoices that are not yet due. Companies need to grant credit only to debtors that have a good credit rating so that they can easily make use of the invoice factoring solution from any factoring company.
Making use of a reputable factoring company can help a business retain its clients since they have a working debt collection structure that is proven over time. A business should not accept to lose clients because they have made use of the invoice factoring solution.