Invoice Factoring

Learn how invoice factoring works with Skippr

What is invoice factoring?

Invoice factoring is a type of invoice finance that lets businesses access cash that’s tied up in unpaid invoices. Rather than having to wait for those invoices to be paid, invoice factoring can release those funds upfront and they can be used to fund business growth.

Invoice factoring involves a business selling its accounts receivable (invoices) to a third party called a Factor at a discount to the full invoice value. Typically, factoring companies advance up to 80% of the invoice value upfront and when the invoice is paid, the extra 20% is paid back to the business less a fee.

With invoice factoring, as the invoices are sold to the factoring company, the business hands over responsibility for the collection of the invoices. This can be a good thing as it can free up resources to focus on running the business. The downside can be that the factoring company might not manage your customers in the same way you would. As your customers are aware that the invoice factoring company is financing your receivables, this is known as disclosed invoice factoring.

Repayment
When your customer pays the invoice
Charges
Interest 8 - 15%
Fees 0.75% - 1.5% per drawdown
Speed
Same day funding
Collateral
Invoices are the security

Pros

Don’t need to wait for the invoice to be paid to receive funds
Invoices are collateral not real estate property
Based on credit of your invoiced businesses
Flexible access to funding
You aren’t responsible for invoice collections

Cons

Cost will be higher than if real estate security is used
Your customers will know you are using invoice factoring

What is the difference between Invoice Factoring and Invoice Discounting?

Invoice Factoring and Invoice Discounting are both forms of invoice finance. There are few differences between invoice factoring and invoice discounting though, and these are mostly around who controls and manages the accounts receivable ledger and whether your customers are aware of the lender.

With invoice discounting, you keep control of your accounts receivable ledger. That means you will be solely responsible for dealing with your customers to get your invoices paid. Some borrowers prefer this as they can keep control of their customer relationships. With invoice discounting, your customers will not know there is a lender in the background which is why it’s called confidential or non-disclosed invoice financing or invoice discounting.

Invoice factoring is when a business sells its invoices to a third party invoice factorer who then manages the ledger and collects the payments. A benefit of this for businesses is that responsibility for invoice collections is passed to the invoice factorer so the business can focus on other things. Because the invoice factorer provides these additional services, it can be more expensive than invoice factoring where collecting invoices is retained by the business. Given the customers are aware that the invoices have been sold to a factoring business, this is also known as disclosed type of invoice finance.

How does invoice factoring work?

If customers had reasonable payment terms and always paid on time, there would be less need for invoice factoring but unfortunately that’s rarely the case. This is why invoice factoring and other forms of invoice finance have been used by businesses for thousands of years and is becoming a much more common in Australia.

Having reliable access to cash flow is essential for any growing small business. Whether it’s for paying suppliers, your employees, investing in equipment or stock or simply having the confidence to take on that big new order, having cash available when you need can ease a lot of the stress of being a small business owner.

How invoice factoring helps cash flow

Invoice factoring lets you unlock cash from your unpaid invoices at the time of issuing your invoices. Instead of waiting for your invoices to be paid, you can smooth business cash flow and bringing forward those amounts you are due and they used for business operations or to invest in growing your business today.

What will invoice factoring cost you?

If you are prepared to offer your home as security for a business loan you will almost always get the lowest cost of funding for your business. The other extreme is unsecured business loans where no security is taken and lenders have to charge more for the additional risk.

In between real estate secured loans and unsecured business loans sits Asset Based Finance. This is where a borrower uses an asset on the balance sheet of the business as security for a loan. Common examples of asset backed finance are vehicle finance and equipment finance. Invoice factoring and other types of invoice finance are other examples of asset based finance. By using your accounts receivable ledger as collateral, you can lower your cost of funding without having to mortgage your home.

When is invoice factoring worth the cost?

Invoice factoring is often more expensive than a loan secured by real estate but many business owners probably don’t want to mortgage their house for the business. Invoice factoring is also more flexible and less expensive than unsecured business loans as business owners can draw funds against invoices only when you need a cash flow boost and you will not be paying interest on funds you don’t need. Invoice factoring finance is also repaid when your invoices are paid and not regular repayment periods which a lot of borrowers like.

The funding flexibility of invoice factoring and other types of invoice finance can provide peace of mind for business owners knowing that cash can be unlocked from the ledger when required. It can also give business owners the confidence to invest in their business and take on new orders knowing that funding them won’t be an issue.