Invoice Factoring Explained
Banks attempt to be the key business partner for their customers. They offer an array of services to assist in helping customers establish their businesses and grow. However, a bank can’t be all things to all clients, and sometimes the working capital needs of a banking client strain the limitations under which a bank can provide credit. In many cases, the bank might not want to lose an otherwise great customer. There is still tremendous value in maintaining a cash management relationship or providing certain types of financing.
If working capital or cash flow are concerns, invoice factoring might be able to help the client and the bank.
What is invoice factoring?
Invoice factoring provides cash flow and working capital to a customer when a company sells its unpaid invoices (the receivables) to a third party, the factoring company. In return, this third party provides the company with immediate cash, which is typically an agreed upon percentage of the invoice amount. Once the invoice is paid, the remaining balance - minus a fee - is paid to the company.
Invoice factoring gets a company paid faster than waiting for their customers to pay invoices. In fact, once a factoring line is set up, invoices can often be purchased within 24 hours of the invoice being issued. This speeds up cash flow and provides working capital for the company to pay operating expenses and grow without adding debt and increasing leverage.
Invoice factoring is NOT:
- a loan
- only for distressed companies
- a financial service of last resort
- a predatory lending practice (such as a Merchant Cash Advance)
- expensive
- complicated
Invoice factoring improves cash flow without additional leverage by getting B2B companies paid faster for the work they've already performed and invoiced.
What types of businesses benefit from invoice factoring?
Business-to-business (B2B) companies that have significant amounts of cash tied up in their accounts receivables are typically good candidates for factoring, especially if their customers take more than 30 days to remit payment.
Some specific business circumstances that also make factoring an excellent choice to solve working capital challenges are:
- Strong sales and customer credit but weak financial ratios and have been unable to qualify for a traditional bank loan due to not meeting the credit criteria.
- Companies experiencing rapid growth or rapidly changing credit needs.
- New or limited time in business.
- The business is unable to meet current bank covenants.
- Complex ownership structures, private equity backed, or foreign ownership.
- Industry tolerance (can be economic, or environmental, social, and governance [ESG] related).
- The company has been placed into a non-performing asset group (workout, turnaround) at their bank.
- Companies losing money.
- Companies with few customers, resulting in high debtor concentration.
In some of these cases, the company may be performing well, but the bank is not able to provide a traditional loan or line of credit.
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How can invoice factoring help a banking customer?
Speeds up cash flow.
As noted earlier, when companies factor their invoices, they receive payment for those invoices faster than if they wait for their customers to pay. This provides working capital and improves cash flow. Improved cash flow results in the ability to purchase more inventory or raw material, or add employees or equipment if needed, which results in having more products and services to sell, which results in increased revenue.
Especially for start-ups, where initial inventory or raw material purchases consume cash, invoice factoring accelerates the payment process, resulting in faster incoming cash. This cash can then be invested back into the business.
Grows as the company grows.
Invoice factoring grows as a company grows. As the sales and revenue increase, so may the factoring line. It becomes a steady and reliable source of incoming cash.
Assists the accounts receivable (AR) department.
Often, the invoice factoring company can assist a new or relatively unsophisticated customer in documenting and billing for their products and services in an accurate and timely manner as well as with the collection of outstanding invoices. These back-office services by skilled professionals act as an extension of the company's accounts receivable department, which reduces the AR department's workload and increases efficiency.
Provides industry experience.
A factoring company can actually help a customer vet potential customers and establish market terms related to the payment for services and products. The factoring company approves a customer for factoring services based on the creditworthiness of the customer's customers. If the factor has experience within an industry, they often have an extensive database of debtors (the customer's customers) and historical knowledge of how quickly those companies pay. This can help a company determine if they want to do business with a potential customer before they ship any product or provide services.
What's in it for the bank?
When you refer customers for invoice factoring, you are providing them with a means to improve their cash flow without taking on new debt. Additional debt could negatively affect their debt-to-income ratio or other financial covenants.
Commercial Funding Inc. is not affiliated with a bank and does not take deposits. Therefore, invoice factoring through CFI does not harm your existing banking relationship. In fact, you can strengthen the banking relationship with your existing customers because:
- The customer remains YOUR customer, the invoice factoring company is simply providing one financial service for the customer.
- Improved cash flow means more deposits and higher balances.
- You can request that the advance payments be deposited into an account at your bank, thus strengthening or stabilizing the customer’s deposit base.
- Once a customer’s financial condition is more established the company is better positioned to get loans or lines of credit from the bank.
What to look for in an invoice factoring provider.
Dedicated Customer Service.
When referring a customer to an invoice factoring company look for a company that has a dedicated customer service or account management group. Large factoring companies, especially the companies that compete mainly on price, typically don't have dedicated account managers or points of contact. Dedicated account managers obtain intimate knowledge of the customer's business and provide continuity and efficiency to help facilitate quick fundings and address any issues that may arise. So when customers need assistance, they are not calling a toll-free number and are not caught in push-button purgatory.
Industry Experience
Look for a factoring company that has experience in your customer's industry. This is important because, as noted before, industry experience can be very helpful to the overall business operations of the customer.
Treats Your Customer Like You Would
The most important aspect in identifying a factoring company is selecting one that will treat your customers as you would treat them. Protecting the banker/client relationship is critical to ensuring the long-term success of your client and choosing the right factoring company to recommend can strengthen your relationships and help the bank and client.
How to get started
Contact Commercial Funding at 888-575-6501 or visit our partners page to discuss opportunities. We will assign you a personal sales manager who will be happy to review the nuances of invoice factoring, discuss how specific clients could benefit, and how you can initiate a factoring discussion with those clients.
