How does Invoice Factoring Work

Maintaining a healthy cash flow is possible with invoice factoring, particularly for companies whose invoices are not paid fast. This has become a popular method of business financing, especially during a slow economy reeling under a cash crunch. Previously this system of financing was considered as a last resort, but because of its high accessibility, almost all types of businesses are considering it, as their first option for getting finance.

The financing is usually done with two installments, when the invoice is purchased by a factoring company. The advance or the first installment is received at the time of sale of invoice, and the percentage advanced depends on a number of factors like market conditions, customer payment record, the track record of the company receiving the finance, and type of industry.

Usually most advances are in the range of 80% of the amount in the invoice. Certain freight and staffing companies manage to get advances as high as 90% as well. The factoring rebate, which is the second installment, is received when the customer has paid in full. This installment includes the remaining amount, minus the fees charged by the company doing the factoring.

There are two types of invoice factoring; one is with recourse, and the other without. In a factoring transaction with recourse, the company providing the finance, can sell back invoices to the company, which remains unpaid in a 90 days period, and it does not matter what the reason was behind the nonpayment. In non-recourse factoring transaction, the financing company will bear the loss of nonpayment, only if the customer has declared bankruptcy during the ninety-day period. However, each transaction can be different, and it will mainly depend on the contract terms agreed upon, with the factoring company.

Assignment notification is another important element of factoring. Here the company providing the finance will perform a quick check of the commercial credit of customers, and then send a notification to them proclaiming their invoices are going to be factored. This notification letter is also called assignment notice, which informs the customer that they will now be dealing with a factoring company, who has financed the company issuing the invoice. The notice will also inform the customer of the new address where the payments have to be mailed. Sometimes the checks can still be in the name of the original company, but delivered to the address of the financing company.

The whole process is quite easy to implement, and has become an integral part of many companies. The main advantages of this type of finance are its accessibility and flexibility. As it is woven into the sales, the finance becomes dynamic, and a company can be assured of a working capital. The company requiring finance should make sure they sell quality products and provide excellent service to their customers. The company also needs a diverse customer base having good credit worthiness. In the present economic situation, invoice factoring is the best form of financing, and can be accessed even when banks have refused to lend amounts.