It is usual for any business to have a long gap between closing the sale and the actual cash flow. Credit sales are necessary for enterprises to increase sales and build customer relationships.
However, it can lead to inadequate cash for working capital and the growth of the business. One way to overcome this situation is through invoice factoring.
In this article, we will provide information about invoice factoring, how it works, and why it is becoming a frontier for lending companies.
What is Invoice Factoring?
Invoice factoring is a business financing option that allows the business to finance slow-paying accounts and meet short-term liquidity needs. In this process, a finance provider (or factor) pays the supplier an initial amount ( 80-90%) of the outstanding invoice and takes on responsibility for pursuing the debtor for the collection of debt.
After the invoice is settled in full, the factor passes on the remaining money to the business, minus a small fee for the services provided by the factor. The cash collected by the company helps in avoiding credit and cash flow problems.
It is also known as ‘invoice discounting,’ ‘debt factoring,’ or ‘accounts receivable financing’ (and sometimes just ‘factoring’). It is easier than a traditional bank loan for a business to raise funds.
Invoice factoring is one of the non-banking funding sources which fills the immediate need for capital for new businesses or businesses without a long track record.
Lenders in this segment accept invoice factoring applications from different businesses considering the current sales volume and the growth potential as a means to approve financing.
Benefits of Invoice Factoring for Lending Companies
Invoice factoring is advantageous to lending companies because the money that they supply to a business is backed by the collateral of the invoice. Suppose the customers of the business pay their bills on time. In that case, the cost of recovery goes down significantly for the lenders, and they can enjoy a better profit margin while collecting payments from the customers.
The lenders simply need to wait out the time period for payments by the buyer to complete the transaction and make a decent profit in the process (with the only exception being the case in which the buyer fails to make payments on time; in such a scenario, the lending company will use its resources to recover the cash).
Benefits of Invoice Factoring for the (Supplier) Businesses
- Easy Availability of Cash
An invoice factoring arrangement provides the company with quick access to working capital. This can reduce the risk of missing important payments such as payroll or supplier invoices and increase credibility.
It is extremely difficult for businesses to wait on payments from slow-paying customers, especially if they make up a large part of the company’s balance. Invoice factoring can provide a sense of regularity to the collections process and reduce problems caused by late-paying customers.
- Lower Risk of Bad Debts
Businesses that don’t have the resources to recover missed payments from their buyers/clients may end up with bad debts. With the secure option of Invoice Factoring and an accountable third party (lending companies), businesses can avoid this risk and expand operations by bringing in new clients.
- Ideal for Seasonal Businesses
Invoice factoring is best suited for businesses that primarily deal in seasons rather than whole-year around. Outstanding invoices can be used to quickly obtain funding for raw materials and make payments to suppliers.
It can help these types of businesses alleviate the cash flow problems arising from slow-paying clients.
Wrapping Up
Several companies often end up with a cash constraint if they don’t have access to traditional bank loans or lines of credit due to slow-paying customers or extended payment terms. Invoice factoring is being used by businesses to secure short-term financing using their invoices as collateral. The lending companies also enjoy a decent profit margin by leveraging their resources.
Finezza has developed a wide variety of products, including Loan Origination Software and Loan Management Software that helps banks, NBFCs, and other lenders track and manage credit applications, process KYC documents faster and streamline the entire lending process.
To implement smooth and efficient processes for your financing needs contact us today!
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