What is invoice factoring?
Invoice factoring is a kind of finance where you sell some of your due invoices to a third party to improve revenue stability and cash flow. A factoring company will immediately pay you most of the invoice amount and then collect 100% of the payment directly from your customers. There are many benefits and disadvantages associated with invoice factoring for sole traders and businesses as well. This article discusses what it is and how it works, and more. Keep reading.
How does factoring work?
You might be in doubt about how you “sell” an invoice to any third-party business in order to get payments. Read the simplified steps below to know what is invoice factoring and how it works.
- You usually sell goods or services to your consumers.
- You raise invoices to the customers for sold goods and services.
- You sell the outstanding invoice to a factoring company. Then the factoring company immediately pays a significant amount of the invoice to you. They often spend up to 80 to 90% of the total amount after they have verified that all the invoices are accurate.
- Your customers pay the invoice amount to the factoring company directly, and then the company follows invoice payment if necessary.
- Then, the factoring company pays you the remaining amount, excluding their fees, once they receive the total amount from the customers.
When a sole trader should use factoring
It is preferable to use invoice factoring when you regularly have a lot of customers to whom you raise invoices. If your cash flow is suffering due to outstanding invoices, going for factoring is the right option.
For example, if you sell on a monthly basis, most of your customers will pay the due amount within 30 days. Some of them may need chasing, and some may not. On the other hand, some other customers may also go beyond the limit. The due amount of those 30 days determined your revenue that might represent your potential cash flow in bulk. But it may suffer if some of your customers go beyond the limit. In such cases, an invoice factoring accounts receivable payments and allows you to release blocked payments to allow cash flow immediately.
The money can be used to:
- Manage short term expenses
- Take benefit of seasonal market opportunities
- Pay loans
- Or for any other reason that might be affecting your business.
Advantages linked to factoring
- Improved cash flow
By using invoice factoring, you can get most of your invoices paid instantly instead of having to wait for the customers to pay them. It makes business forecasting and planning more apt and lets you benefit from current opportunities.
- Cheaper and more accessible than a bank loan
Invoice factoring almost works like a loan but does not charge you the same. It is a much easier and cheaper process to go for if you need money for short-term needs. It can instantly provide you with the money by charging a small amount.
- Better chance for trade surviving
Better cash flow allows a trader to have a better chance of survival. Many traders quit due to a lack of cash flow, and invoice factoring is the right solution to that as long as you use it the right way.
Invoice factoring for sole traders can turn out to be quite beneficial. However, it is sure to be limited to certain conditions. If you think this to be the right solution for your circumstances, opt for a factoring solution right away.