What Happens in the Financing Arrangement Known as Invoice Factoring?
In bookkeeping, accounts receivable includes all the invoices a business has issued and is still due payment. This is in contrast with accounts payable, which includes the bills to the business that it has not yet paid to creditors. As payments are made, ledger entries are filled to note transactions that are complete. A type of Account receivables financing known as factoring is a method of obtaining payment from a third party for outstanding invoices to improve cash flow. This is particularly helpful for small organizations and start-ups.
Types of Arrangements
Businesses can obtain factoring service in two primary arrangements. One sells all outstanding invoices to customers to the third party financing company, whereas another sells specific invoices. The second strategy is known as spot factoring. Business owners typically use it for larger outstanding amounts that are restricting the organization’s ability to buy inventory or fill other needs. There are a few distinct benefits to the spot factoring model of financing.
Acquiring Lucrative Contracts
Organizations typically expect payment on invoices to customers within 10 to 30 days, and they note the terms of sale on the invoice or in a contract. Sometimes a lucrative sale requires waiting several months for the full payment, although partial payments may be made in the meantime. Agreeing to these terms is helpful for acquiring the sale but also poses a problem for cash flow.
Avoiding Extra Fees
As with all invoice factoring, the company the client pays a high percentage of the balance due on the invoice and accepts the remainder as its fee. By choosing only one or two invoices to finance, the business avoids having to pay larger amounts in fees. In addition, there is no contract required for this type of financing. The business can use the service one time and not be obligated for any future transactions.
Dealing With Slow Payers
Another advantage is being able to use a service such as Business Factors & Finance mainly for invoices that haven’t been paid on time. For instance, a valuable client may be a bit sluggish with payments, sending the money within 60 to 90 days instead of the expected 30. Receiving the money sooner can make a big difference for the small organization.