If your business is new, you might end up with cashflow problems at some stage. Since you will need to order from your suppliers to fulfil your customer’s orders, you will then need to pay your own invoices before your customers pay yours (if your customers have payment terms). What can you do if your own customers have not paid and your suppliers are chasing you for payment?
Hoping that your customers will pay you on time could still mean that you are late paying your own invoices, which could mean that you incur late payment fees. If this trend continues, your cashflow problems will soon get worse. For most business owners, accessing funds to solve their cashflow issues seems like the only solution. But while some businesses will head straight to their business bank to apply for a loan, others will choose a different method, known as debt factoring. But what is it and why is it often preferable to a bank loan.
What is Debt Factoring?
Debt factoring is also known as invoice factoring and is the process of selling unpaid customer invoices to a third-party company. The experts at Thales Financial tell us that it is different from borrowing, as there is no debt involved. The finance company takes on the responsibility of collecting the payment of the invoice from the business’s customer and then charges the business a fee for the service. Let’s look at an example of how debt factoring works.
A business gets an order from a customer worth $5,000. In order to fulfil that order, the business must go to its supplier and place an order for products worth $4,000. The supplier sends the goods to the business along with the invoice, which is due for payment in 30 days. The business then picks the customer’s order and sends it out along with its invoice. But this customer has payment terms of 60 days. After 30 days, the business must pay the supplier, but the customer is not due to pay for another 30 days.
The business owner does not have the cash on hand to pay his supplier, but if he waits for the next 30 days then he will be overdue and may have a penalty to pay on top of his invoice. In this instance, the business owner might decide to factor the customer’s invoice. The business owner will submit the invoice to a factoring company, who will advance either the full $5,000 (the amount of the customer invoice), or up to 90% of it. The business owner can now pay his supplier on time (or even earlier), depending on when the invoice is sent to the factoring company.
When the factoring company collects the payment from the customer, it will send the remaining 10% (if applicable) minus fees to the business owner.
Choosing Debt Factoring Over a Bank Loan
Bank loans are simply not available for all business owners, particularly those with little credit history. Even those that do have the means to apply for a bank loan will use debt factoring instead because it is quicker and easier to access. Unlike bank loans, debt factoring does not require any collateral and business owners have the option for flexible financing with funding limits that increase as the business grows.
In conclusion then, invoice factoring is a quick way for a business to generate the funding required to boost cashflow and keep the business running efficiently. It can be accessed by those without the means to apply for a bank loan, and it is seen by many businesses as the better option for a short-term cash injection.