The factoring business has been around for centuries, starting all the way back to the Renaissance era in Europe. To this date it is one of the key essentials that any growing business should utilize if they intend on staying afloat and to eventually expand. So what is invoice factoring and why is it essential for a business’s survival? In order to help you understand and get a firm grasp of how this process can indeed help your business, here is a quick dive at the definition and individual aspects of factoring business
Is It a Loan?
First and foremost, factoring invoices are not a type of loan. A loan is where an individual or business borrows money and then pay it back with interest. In factoring, the company is simply buying your assets; in this case, they purchased the amount listed in your invoice.
For example, a client gave you a project, which takes 6 months to complete and your current invoice indicates that the fee they’ll pay you at the end of the term is roughly $100,000. Unfortunately, since your business is not paid at the onset, you could possibly face financial setbacks until such time the project is completed. To solve this problem, you may approach a factoring company.
How Does It Work?
The factoring company will assess your invoice and this can usually take three to five days until they approve and deposit the amount to your bank account. What happens is that the company will buy your assets (invoices). Usually the company will pay you 80% first and then the remaining 20% when the client pays the full amount.
This means that you have roughly $80,000 right at the very beginning. This is money that you can use for raw materials and funding the project to its completion. By the end of the term you won’t be getting the full $100,000; the factoring company will charge you certain fees (usually no more than 2%) in return.
Collecting the Invoice
Now there are two options. You can either notify your client about the factoring agreement and then when the job is complete they will directly pay the factoring company instead of handing the payment to you. Most companies do not choose this route. Instead, they usually just let the client pay them and then hand the money over to the factoring company. This makes their agreement private and kept only between the two parties involved.
A factoring company purchases your accounts receivable and will then collect the actual payment from your client later on. A loan, on the other hand, is where you borrow money from a lender with the intention to pay them back, usually with interest. The problem is that a loan can carry high interest rates, high penalties, and the process can take too long. A factoring business is like getting paid cash and it is really necessary in order for a business to be able to fund its daily operational costs.