In today’s economic turmoil most business firms are looking forward to a way of generating cash. This has become much of a frequent challenge since every business requires spawning in a continuous stream of cash flow for the smooth flow of its operations. In such situations, one easy way that most business firms choose to get ready cash is the invoice factoring method, especially by small business firms who have limited overdraft facility.
How does it work?
Invoice factoring is essentially an important way used by businesses to finance their working. In some ways it is a financial transaction whereby a business can sell off its invoices or accounts receivables to a third party. Invoice factoring relates to the sale of an essentially financial asset that is associated with the debtor’s liability to pay the owed money. Such sale of invoices to a factor is done on a discount for the business to gain some ready cash.
Why is it used?
Today factoring is considered as a great alternative method for most business firms. This is especially true for small businesses because in sight of an economic crisis most banks today have tightened up the lending requirements. Though the sale happens at a discount, the risk of not receiving money from the debtor is passed onto the factor and in totality your risk factor gets reduced. Also it helps you to get cash readily. Also if you go for non-recourse financing options, any kind of fraud in connection with such accounts receivables will not affect the business since it does not legally have any binding on the business. This is why this option still remains in popular demand even today.
What are the benefits?
There are many benefits of going in for the factoring source of cash management. Some of them can be outlined as below:
- The factor considers the value of the receivables and not the firm’s creditworthiness while making such purchase. Hence even firms who are in a bad shape can make use of such alternative.
- The biggest benefit of choosing invoice factoring is that you get your cash flow quite earlier, typically in 1 business day. This counts a lot in leveraging your business requirements.
- Going for other sources of business financing could be a tedious task and could become quite overwhelming at times. Also unless you have good collateral to pledge against your loan, not many financing options might be available to you.
- Finally, factoring companies have been generally found to be more effective in collecting debts rather than business firms since they have better dedicated resources in this regard.
What are the costs?
Compared to most other financing options, the cost of invoice factoring has been found to be the least. It is usually reasonable and the factor takes up your risk of debtors at comparatively a very cheap cost. The usual costs involved with factoring are interest and fees. The interest rates are usually calculated at around 1.5 percentage over base rate and in some cases it could go up to only 3 percentage over base rate. Compared to the bank overdraft rates, these rates are almost equivalent or sometimes even cheaper. Interest is calculated on a daily basis as well. As for the fees involved, the amount charged depends upon your business turnover, the volume of invoices you handle and the total number of customers you have. Typically this is estimated to fall within 0.75 to 2.5 percentage of the turnover.
This has remained one of the oldest and yet most popular methods of cash management tool and even today it is preferred way over obtaining bank loans.