Invoice financing has become a massively used method for entities that are in need of cash and would not want the hassle and interests of regular loans and the lengthy application to approval time that comes with it.
By definition, invoice financing is a method by which companies derive funds from their unpaid customer invoices or in other terms its receivables. We all know that sales can happen on cash or on credit. With the latter, businesses will have to wait for a certain period of time before collections are made and the actual realization of cash is apparent. This can be bad in a way because even with a rising amount of sales, the amount of cash that the company has at hand and can use is not available. Cash is locked up as receivables. Invoice financing frees them up.
But what about factoring? Where does it come to play? It is in fact a method of invoice finance apart from the other one called discounting. Today, we’ll focus on the former.
Basically, factoring is the sale of the corporate assets which in this case are the receivables. The company, in order to free up the cash, sells off the right o collect against the customer invoices to a financial firm or a factor as what they are mostly referred as. The factor in turn provides for the cash which is correspondent to the value of the receivables subjected. This is oftentimes equivalent to around eighty up to a ninety five percent of their value. The remaining balance, which is less any agreed upon fees, is only released once the full amount has been paid by the owing customers.
The reason why factoring has become widely used is due to its numerous benefits to wit:
For one, it is a very quick method to acquire funds. In fact, it can take only around 24 hours at the least for the cash to be made available. This makes them very useful for emergency situations.
Second, it banks on the credit rating of the owing customers and not on the business itself. Therefore, no financial statements will be necessary nor are credit rate and history an issue.
Third, it does not appear as a debt in the financial statements but rather an increase in cash and a decrease in the trade receivables making. This is in fact a very good effect brought about by invoice financing and factoring part from the absence of any rising interest expenses.