How to get small business funding with invoice factoring
Many small businesses and startups are familiar with the problem of funds shortage. The sellers do not get paid on time and fail to support the production process.
The regular situation is that the consignment of goods has already been shipped, but payment for it has not yet been made. Money is critical to keep the business going, to purchase new raw materials, to pay to employees, to settle the debts and so on.
There are many costs that an entrepreneur must spend. In such cases, invoice factoring is one of the best solutions.
What is Invoice Factoring and How Does It Work?
The most common definition of factoring is the acquisition of corporate debt by a specialized financial institution or bank. These can be deferred payments for goods, works, services. This form of interaction allows one legal entity to receive goods with deferred payment, and others to accumulate working capital without freezing them for a long period.
Credit institutions also have their profit. When it comes to non-specialized banks, factoring brings them solid benefits (the specific percentage depends on the amount of the transaction).
Factoring operations usually involve three parties:
- a factor (factoring company or bank) which is the buyer of the claim;
- the supplier of the goods (the creditor);
- the buyer of the goods (the debtor);
Factoring started in the USA at the end of the 19th century. Then it found application in the countries of Western Europe. In the 1980s factoring operations have been actively conducted by banks in Australia, the Middle East, and Southeast Asia. By the mid-1990s the volume of factoring operations had the following geographical distribution:
- Europe - 56%;
- America - 30%;
- Asia and the Pacific coast - 13%;
- Africa - 1%.
The main are the following ones:
- Recourse factoring. It is a type of factoring in which the bank acquires from the client the right to all amounts due from the debtor. However, if it is impossible to recover the full amount from the debtor, the client who has transferred the debt is obliged to reimburse the missing funds to the bank.
- Non-recourse factoring. It is a type of factoring where the factor acquires from the client the right to all amounts due from the debtor. If it is impossible to recover the full amount from the debtor, the factoring company will suffer losses (although within the framework of the funds paid to the client).
Factoring is developing so fast thanks to its inevitable advantages:
- Invoice factoring increases the competitiveness of the company due to the possibility of providing customers with a long delay in payment without cash gaps;
- Invoice factoring accelerates the cash flow of the business. It allows timely payments to the contractors. Paying off the contractors on time, business owners can receive discounts on the purchase of raw materials and equipment, and sell their goods with a margin due to the provision of an installment plan;
- factoring does not require collateral and surety;
- factoring is not considered a loan and does not affect the balance sheet and financial attractiveness of the business for investors;
- factoring costs are part of general expenses. It reduces income tax;
- the factor may additionally take the administration of receivables and completely free the entrepreneur from accounting for receipts for deliveries.
- High rates. Compared to lending, factoring is quite expensive. The factor tries to minimize the risk and charges a rather high percentage for providing a loan, as there is no guarantee of the return of its funds.
- When making a deal, the company receives no more than 85–90% of the debt value.
- The service is provided mainly to regular highly- reliable customers and is not available for companies with many small debtors.
- factoring is an additional source of financing (lack of financing is a common thing for a rapidly growing company);
- factoring makes it possible to defer payment terms (delays in payments may literally kill the companies that do not use external sources of funding);
- factoring is an opportunity to get financing for businesses that currently do not meet the bank's eligibility criteria;