Accounting And Payroll

How Invoice Factoring Actually Works

When businesses are struggling to get their invoices paid, they sometimes use a service which is known as invoice factoring. This kind of service involves a second party working with clients to get the invoices paid.

While this sounds good in theory, it can also come with some issues when it comes to the company taking a cut of the money.

In this article, we are going to look at how invoice factoring works and discuss some of the benefits and drawbacks of using this kind of process. Keep reading to find out more.

What Is Invoice Factoring?

If you are not familiar with the term invoice factoring, you should know that it involves selling your invoices to a company that will aim to get them paid.

Usually, this company will work directly with your clients and get the money so that they are not out of pocket. There are many invoice factoring companies out there right now and some specialize in other kinds of financial help.

Invoice factoring is commonly used by small businesses who are struggling to get their business going because of customers who are slow to pay their invoices.

Small businesses can struggle to get loans due to a lack of financial history and credit. With invoice factoring, this can solve the problem.

How Does It Work?

When you are hoping to use an invoice factoring service, there are many steps that you need to go through. The first step involves finding the right factor for the job.

There are many companies that will offer this service so you need to make sure that you are weighing up all of the options.

Take a look at the percentage that the company will take from your invoices and don’t forget to let them know how many invoices you plan to send on. You should also consider their level of customer service as they will be dealing with your customers on your behalf.

The next step involves creating a factoring agreement that needs to be approved. The invoice factor needs to make sure that your customers are reliable and that they are going to be able to receive the payment eventually.

You’ll need to sign an agreement that includes everything from the payment plan to the fees that are associated with it.

Usually, once assigned to the invoices, the factor will give you an advance payment. This is named the advance rate and it will be a percentage of what you are owed. The rate of this will usually be determined by the industry that you are working in and how stable your business is.

Most companies will send a notice of the assignment to your clients. This will include information about how they can make payments and get back on track.

The final step in the invoice factoring process involves the collection of payment. This will usually happen after the deadline has passed and your clients are all paid up.

At this point, you will receive the rest of the funds from your factor and they will deduct the fee that they are charging for this. Then, if you are interested in using their services for further invoices, you can continue with the process again.

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Are There Additional Fees

One of the things that you should be aware of when you are using an invoice factor is the additional fees that might be charged. These kinds of fees will vary by company but it is important that you are aware of what you might face before you agree to this kind of service.

Some of the common fees include an incremental fee, account setup fees, a renewal fee, credit check fees, and a monthly minimum volume fee.

You can discuss these fees with your invoice factor before you begin and find out the details before you agree to something which is outside of your budget.

Risks Associated

Another thing to think about when you are considering invoice factoring is the risks associated with this kind of process. Firstly, your clients might not be happy to hear that you are having cash flow issues as this is usually the reason for a company to use this kind of service.

Customers might also get confused as to why a different company is contacting them to get them to pay invoices. This can often lead to invoices still not getting paid as they do not want to pay an external company.

Further to this, you might find that your customer service levels drop due to the introduction of a third party company.

You need to continue working with your customers and showing them that you care and sometimes, invoice factoring companies can be a bit faceless. If you do go down this route, try to maintain your customer service levels.

Are There Other Options?

While many people believe that bank loans or invoice factoring are the only options for short-term financing, this is not the case at all. There are some companies out there who will give you the full amount of the invoice right away and won’t take away a large percentage of it.

These companies will also keep you in touch with your customers which means that there is a reduced risk of the customer service level dropping.

Make sure to do your research and figure out the best option for you in the future.

Final Thoughts

Now that you know a bit more about invoice factoring and how it really works, you can figure out if this is the best route for you to take. Consider the process involved and the overall cost of invoice factoring.

There are many companies out there who will do this for you but not all will offer the best possible service. Make sure to take on board all of the advice that we have given you and this should help you to make the right decision for you.

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