What is Invoice Factoring?

What exactly is Invoice Factoring?


Invoice Factoring is a financial transaction between two companies. A company will agree to sell its invoices or accounts receivable, to a third part for a discounted price, this third party is called a factor. Factoring is not a loan, as loans are usually dependent on a company’s assets, credit history and sales forecast. With factoring, it is the company’s customers who are assessed as credit-worthy

What are the Invoice Factoring Types?

There are several types of Invoice Factoring, there is Advance factoring, where the Third Party Company or ‘factor’ will advance the selling company a certain percentage of the purchase price of the invoices, this is usually in the region of 70-85%. The other type of factoring is the maturity Invoice Factoring. In this situation, no advance of cash is given, rather the purchase price is paid on the average maturity date of the accounts being purchased.

 

What is invoice factoring: around the worldWhat is invoice factoring

Factoring is often mistaken for Invoice Discounting, which is borrowing against the invoices as collateral. Factoring is a sale of invoices to another company not a loan against them. However, in countries like the United Kingdom, Invoice Discounting is considered a form of factoring. This is because it involves the assignment of receivables and as such is not considered borrowing.

How does Invoice Factoring Work?

There are three parties involved in Invoice Factoring, the debtor, the factor or buyer and the party who acts as a seller for the debtor. The receivable or Invoice, is treated as a financial asset and the debtor decides how many receivables they are going to sell. They then sell the receivables to the factor for a discounted price. This is usually in the form of an Advanced Factor in exchange for cash.

Factoring includes advancing funds to much smaller firms by firms with better credit worthiness. These Factors usually offer combinations of cash and support to the smaller firms in return for the invoices. This support may take the form of the factor accepting the credit risk of approved accounts. Information of creditworthiness of prospected clients, and making calls for any collections as needed.


What is invoice factoring:Ownership of receivables

Once the factor has received the sold invoices, they essentially have ownership of the receivables. They receive all payments made by the seller in relation to the invoice amount. However, if the transaction was a nonrecourse factor, then the factor bears the loss if the account holder of the invoice fails to pay due to financial inability. The account holder is notified that the invoice has been sold, and the factor then bills the account holder and collects any monies.

What is invoice factoring: risk involved

There are a number of risks associated to factoring, these include.

  • Fraud: Fake invoicing, misdirected payments and non-assigned credit notes can all be a risk. Fraud insurance can minimise this as well as a company audit.
  • Tax Risks: These risks are different in each country, to the factoring company has to check the legal requirements prior to the transaction.
  • Operational Risks: This includes contractual disputes.
  • Counter Party Credit Risks: This usually means that the original seller of the invoices is deemed a credit risk by other parties. The risk of this can be lessened by the debtors being reinsured.

So if your asking what is invoice factoring, understand there are many firms who consider Invoice Factoring as a good way of protecting themselves from bad debt and possible bankruptcy, This is especially true of smaller firms who are growing and do not want to be saddled with too many bad debts. This is a financial transaction that is becoming more and more prevalent in the current economic climate.