An invoice factoring facility is a type of debtor finance that allows businesses to sell outstanding invoices (accounts receivable) to a financier for cash upfront rather than waiting for 30, 60 or 90 days to get paid. Invoice factoring can be further categorised into a disclosed or confidential facility. Let’s explore what this entails.
What is Invoice Factoring?
Invoice factoring is a financial transaction where a business sells its accounts receivable, or outstanding invoices, to a third party known as a factor. This arrangement allows businesses to access immediate cash flow, rather than waiting for customers to pay their invoices, which can take 30, 60, or even 90 days. By leveraging invoice factoring, companies can maintain a steady cash flow, ensuring they have the funds needed to cover operational expenses, pay employees, and invest in growth opportunities. This type of debtor finance is also referred to as accounts receivable factoring, invoice financing, or sometimes accounts receivable financing.
The Factoring Process
The factoring process typically involves several straightforward steps:
- Selling Invoices: A business sells its outstanding invoices to a factoring company. This step initiates the factoring transaction and sets the stage for immediate cash flow.
- Cash Advance: The factoring company advances a percentage of the invoice value to the business, usually within 24 hours. This advance provides the business with quick access to funds.
- Final Payment: Once the customer pays the invoice, the factoring company sends the remaining balance to the business, minus a factoring fee. This final step completes the transaction, ensuring the business receives the full value of the invoice, less the agreed-upon fees.
Disclosed (Notified) Factoring
A disclosed factoring facility is when the financing arrangement is made known to and acknowledged by all three parties: your business (supplier), your customer (debtor), and the financier. Not all factoring companies provide non-recourse factoring options, highlighting that this type of agreement comes with more risks for lenders and stricter requirements for borrowers.
A Notice of Assignment (NOA) is sent by the supplier to the debtor to inform the debtor that invoices are now assigned to the financier. Therefore, all assigned invoices under the facility are to be paid to the financier.
The notification is only done once during the set-up of the facility and remains in place for the lifetime of the facility. Most large corporates, MNCs, and government agencies are familiar with a disclosed factoring arrangement.
Confidential (Non-Notified) Factoring
A confidential factoring facility is when the financing arrangement entered between the supplier and the financier is not made known to the customer (debtor). Your business simply draws down funds against outstanding invoices. In most cases, the financier will require that customers pay your invoices to a specified bank account your financier controls or has access to.
Factoring Costs and Fees
Factoring costs and fees can vary depending on the factoring company, the industry, and the type of factoring service chosen. The main costs associated with factoring include:
- Discount Fee: This is a percentage of the invoice value, typically ranging from 1.5% to 5%. It represents the cost of the factoring service.
- Service Fee: An administration fee charged by the factoring company, usually between 0.5% and 2.5% of the invoice value. This fee covers the operational costs of managing the invoices.
- Factoring Fee: A flat fee charged by the factoring company, usually ranging from 1% to 3% of the invoice value. This fee is for the overall service provided by the factor.
Understanding these fees is crucial for businesses to accurately assess the cost of using a factoring service and to ensure it aligns with their financial strategy.
Pros and Cons of Disclosed (Notified Factoring)
Competitive rates
A disclosed facility will offer you more competitive pricing compared to a confidential facility as more risks are mitigated. Some of the risks are:
- Fictitious invoices.
- Double financing – the same invoice is financed with multiple financiers.
- Redirection of funds – invoice payments are redirected back to the supplier without consent.
- Defaults – if the supplier enters administration, the financier can still demand payment from the debtor.
Larger facility limit
As perceived risk is lower for a disclosed facility, this means your business is more likely to receive a larger credit limit when compared to a confidential facility. Hence, more funds to fuel your growing business.
Longer set-up time
The initial setup may take a little longer than a confidential facility due to the Notice of Assignment process.
Invoice Factoring for Your Business
Both types of invoice factoring facilities will give you better control of cash flow. Need to pay salaries at month end but still waiting for your customers to pay? Tax deadlines? Paying your supplier to secure stock? No worries, just sell one or more of your invoices to get funds into your business today.
When selecting a factoring company, businesses should consider several key factors to ensure they choose the best partner for their needs:
- Reputation: Research the company’s reputation online and ask for references. A reputable factoring company will have positive reviews and testimonials from satisfied clients.
- Experience: Look for a company with experience in your industry. Industry-specific knowledge can be invaluable in understanding the unique challenges and opportunities your business faces.
- Fees: Compare fees among different factoring companies. Understanding the cost structure will help you choose a company that offers competitive rates.
- Service: Consider the level of service provided, including customer support and online account management. Excellent customer service can make the factoring process smoother and more efficient.
- Flexibility: Look for a company that offers flexible factoring options, such as selective factoring or non-notification factoring. Flexibility can provide your business with tailored solutions that meet your specific needs.
At Invoice Interchange, we offer online invoice factoring. Simply upload your invoice onto our platform. Upon successful verification, funds will be in your business bank account within 24 hours. The facility is fully flexible, which means there are no contract lock-ins, no minimum drawdowns, and no monthly fees. You pay as you use. It is so simple.
