By Odhiambo Ocholla
Due to the credit squeeze and many banks’ unwillingness to lend, businesses are finding it difficult to raise money to finance their activities. Factoring and Invoice Discounting can allow a company to improve its cash flow.
In the current economic downturn with many banks’ unwillingness to lend, businesses are finding it difficult to raise money to finance their activities using traditional sources such as overdraft facilities. Faced with this situation companies are advised to use other sources of financing such as factoring and invoice discounting.
Factoring and invoice discounting allow a company to improve its cash flow by borrowing against legitimate invoices that have been raised. Using this facility the company is usually able to access 80% of the invoice value immediately without having to wait for the normal payment period.
Commercial banks offering invoice discounting services require that for Invoices to be discounted must be from reputable institutions to curb abuse of the facility. As a matter of fact, waiting to get paid on their invoices can create cash flow problems that affect the business ability to meet its day to day operations expenses. This problem can be more frustrating if the business has a number of orders that it cannot fulfill because its cash is tied up in unpaid invoices. There are two options in this scenario which the business either take out a painful bank loan, or find an invoice discounting provider.
Invoice Factoring
Invoice factoring is a process whereby a business sells its current, unpaid accounts receivable to the factoring provider. This gives the business cash, up front, to take care of operating expenses like covering payroll, buying supplies, and paying benefits and workers compensation. Invoice factoring allows businesses to attain the funds they need based on the amount of money they anticipate on receiving from clients. Businesses of all sizes can utilize invoice factoring, but they can be most useful for small to mid-sized businesses or businesses that are relatively new. Most businesses in financial crisis look to bank loans for the funds they need. But businesses that do not have financial-track record, weak balance sheet, history of financial problems or undergoing big changes, are often unable to find a willing lender at any price. Invoice factoring is an effective cash management tool that can help business run without having to worry about collecting on invoices.
How does invoice factoring work?
Invoice factoring, also known as accounts receivable factoring, is a financial tool that allows small business owners to capitalize on the power of their slow paying invoices. It allows you to turn your invoices into immediate cash, enabling you to fund your business operations. Although it is not a well-known fact, invoices from strong credit worthy commercial clients are excellent collateral, especially for factoring companies. This makes it an ideal financing vehicle for small and mid size businesses. As opposed to most banks that lend you money against hard collateral, invoice factoring companies buy your invoices outright. The factoring company buys your invoices and provides you with funds immediately, while they wait to get paid by your customers. The bank has recourse to the client in case of non-payment.
Cost of Invoice Factoring
The invoice factoring process can be repeated every time you invoice, providing you with a flexible line of financing that grows with your business. Factoring transactions are commonly done as a two-installment sale. The first installment is called the advance and is paid to you as soon as you submit the invoices. Advances can range anywhere from 60% on the low end up to 90% of the gross value of the invoices. The average advance is about 75%.The remaining installment, called the rebate, is remitted to you once the invoice is paid. Factoring fees are deducted from the rebate. It is important to understand that invoice factoring provides access to money based on business activity which is already happening. Having said that, however, invoice factoring or discounting can also be an ideal solution to help improve the cash flow position of a new business.
Because Invoice discounting focuses on cash flow improvement, they are not usually a good way of raising a lump sum for a specific business project.
The writer is an Investment Banker. Email: nyabolla@gmail.
