What is factoring or invoice financing?
Factoring or invoice financing is a form of debtor financing that differs from traditional forms of financing, such as bank loans or credit lines.
It is a term used when a company sells its outstanding debt to a third-party factor or financing company.
The purpose is to gain quick access to liquid funds.
You can handle electronic invoices automatically with Acubiz
With automated and digital invoice management, you can optimize your company’s processes within Expense Management, which helps to streamline your debt collection process with factoring.
How does factoring work?
It allows a company to outsource a portion of its work, so an external firm is responsible for collecting payments from its customers instead of the company itself.
This also means that there is an extra party that needs to be paid for this service. It is worth it for many companies, as the factoring company takes over the collection from debtors and possibly the collection process.
This saves the company time and resources as administrative work decreases.
Typically, factoring works by a company transferring information about its outstanding debts to a factoring company. The company then takes over all administration related to the invoices.
Here is a typical example:
- Delivery: You deliver your product or service to the customer and send an invoice to the factoring company.
- Payment: The factoring company pays you a percentage (typically around 80%) of the invoice amount.
- Customer payment: Your customer pays directly to the factoring company. The remaining proceeds (the amount you borrowed) are paid to you.
It is also typically the factoring company responsible for collection procedures, possible collection processes, and collection of any paid claims.
Invoice financing gives your company more liquidity
When a company needs to hire new staff, invest in product development and marketing, or pay suppliers, it can be difficult if there is poor liquidity.
In other words, it can be easier to keep operations going if there is liquidity to pay expenses and debt obligations.
With invoice financing, a company “borrows” its invoices at 80%, meaning it receives 80% of the invoice amounts immediately from the factoring company. This means that the company does not have to wait until the payment deadline for the invoices before it has liquidity for product development and the like.
A factoring agreement, therefore, makes it possible for companies to strengthen liquidity, reduce the risk of bad payers, and reduce administration time.
Less control... but more stable and predictable liquidity
There are several advantages to factoring that can benefit companies.
But there are also disadvantages, such as the lost profit that the company has had to pay for the factoring service. Or the fact that a company hands over part of its management of debtors and payments to a factoring company.
This means that the company has less control over its bookkeeping.
However, the lack of control is not necessarily a disadvantage, as it can be a considerable advantage to release time and resources for other vital tasks that benefit the company. The specialized employees of a factoring company can also ensure faster and more reliable collection of payments from debtors, which can result in more stable and predictable liquidity.
Often advantageous for companies that trade B2B
It is often companies with extended payment terms, and companies that trade B2B (Business to Business), that can benefit from invoice financing. OR companies with many customers and/or many invoices.
It can also be advantageous for small businesses because it strengthens liquidity and reduces the time spent on administration. The result is that they can free up more time for other essential tasks.
Do NOT choose a factoring agreement if you are a company with:
- Few customers
- B2C (Business to Consumer) customers
- Installment or subscription sales
- Annual revenue below 1.5 million DKK
…otherwise, it becomes too expensive because you have to pay a start-up fee, a financing interest rate (percentage of the invoices), and an administration fee to the factoring company, as they handle the collection of both money, debt collection, and similar.
Do you want to know more?
If you want to learn how to achieve efficient invoice management, you can read about how to get an automatic and digital workflow to handle cost invoices in your company.
Otherwise, feel free to contact us.