December 12, 2022

The Ultimate Guide to Invoice Financing and its Benefits

Your receivables, your capital!

Do you often have to scramble for short-term working capital needs? Is your receivable turnover higher than what you want it to be? If your answer to both these questions is ‘Yes’, then invoice financing is precisely what you are looking for.

The global invoice factoring market reached a high of $1946.5 billion in 2021 and is further expected to reach $4618.9 billion by 2031, with a CAGR of 9.4% between 2022 and 2031. Recovering from the effect of a pandemic, such astounding figures bring the focus back to short-term financing needs for businesses.

If these figures astound you, hold on. We’ve prepared this comprehensive guide here to discuss the intricacies of invoice factoring, how it works, why it matters for your business, its pros and cons and how BridgeUp can make this easier for you. Let’s dive right in!

What Does Invoice Financing Mean?

Invoice Financing is an alternate financing option allowing a firm to sell its outstanding invoices to a third party. This third party offers mostly instant and upfront cash.

Why is it better than traditional financing, though? Because it won’t affect your credit like traditional financing. It doesn’t involve borrowing money but simply, selling outstanding invoices to earn the immediate cash you might need if there’s a cash crunch.

Where can you get the money to pay your suppliers or employees? How do you still purchase machinery, if need be? The solution is: to go for invoice factoring. The best part about it is – you don’t need to wait for the Accounts Receivables (A/R). In fact, invoice factoring is a good way of earning money through your A/R.

Whether it is right for you to opt for invoice factoring depends on your need to increase cash flow. Added turnover earned through invoice financing can help you do that, as it collateralizes A/R.

Remember that profitability doesn’t always entail positive cash flow. Companies having clients with extended payment terms can also find it difficult to meet certain financial obligations. This can easily make the whole scenario so perilous that it would make you doubt whether you’re profitable at all.

Specifically, growing firms and start-ups use invoice factoring for its immediacy and to avoid lengthy traditional processes of receiving bank loans. Although invoice financing can be more costly for your firm than traditional options, it offers an assurance of quick cash when you need it upfront.

Invoice Financing Types

Invoice factoring has various types. Let’s look at some popular categories of invoice factoring:

Recourse Factoring

This factoring option doesn’t factor in bad debt-related risks. The third-party can still get their money if your customers don’t pay. The factoring agreement contains details on how many days after you need to refund the advance.

Non-recourse Factoring

In this kind of factoring, bad debt-related risks are factored in. Specified risks entailing the failure of the debtor to pay are covered by non-recourse financing. Unfair debts tied with genuine disputes are not insured by this factoring option. So compared to recourse financing, securing non-recourse financing can be expensive for businesses.

Advance Factoring

As the name suggests, this is about paying the amount in advance. When the invoice is factored in, the margin and invoice minus the commission are paid to the firm. The margin is generally paid after the debtor has realized payments from its customers. The margin can range between 5% and 25%.

Maturity Factoring

Certain factoring services offer only collection benefits. Under this factoring type, firms receive the invoice amount only after the payments from their customers have been realized.

Bank Participation Factoring

Under this special arrangement, the bank generally pays a factor’s margin. This factoring option can be great for businesses where maintaining a small margin is crucial.

Full Factoring

It is one of the most popular types of factoring. With this, the client is provided with all types of facilities by the debtor, including protection from bad debt, collection, etc.

Supplier Guarantee Factoring

This factoring type is indeed an innovative way of getting out of bad situations. This type needs a factor-taking guarantee for the business. The payment owed to the supplier of the business is guaranteed by the factor, and payments to the suppliers are made after realizing the money from the customers.

Difference between IF and ID

When dealing with invoice financing, it’s not uncommon to get confused between invoice discounting and invoice factoring.

Both are basically asset-based financing options. However, the main difference lies in whether your lender owns the sales ledger or not. It also depends on who is finally collecting the payments from your customers.

In factoring, the financier is responsible for the sales ledger and collecting payments from the debtor’s customers. In the case of debt discounting, these responsibilities are handled by the debtor. The end customer generally doesn’t know there is a financial arrangement between the business and a third-party financer.

How Invoice Financing Works

Invoice factoring service providers specialize in processing invoices on behalf of a borrower. Invoice factoring involves selling some or all of your invoices to a factoring service provider in order to enhance their cash flow.

A factoring company would pay the borrowers most of the invoiced amount on the spot. Moreover, they take the responsibility of collecting the due payment on the invoices directly from the customers. Following is a short process of how it works:

A borrower provides goods and services to its customers and raises invoices.
A borrower sells the raised invoices to a factoring service provider.
The factoring service provides pays 80-90% of the invoiced amount upfront.
The service providers collect payment directly from the consumers.
The service provider pays the remaining amount minus their fee to the borrower once all invoiced amount is collected in full.

How Much Does IF Cost

Honestly, one cannot associate a fixed cost to invoice financing as the need arises on a business-to-business basis, which adds to its dynamic nature. Hence, the first step is to understand how invoice factoring costs are calculated.

There are two basic components to invoice factoring: the discount fee and the service fee. Within both these costs, lie the average base rate costs, which range from invoice to invoice. However, these aren’t very suggestable due to multiple factors associated with them. The first factor to take into account is the discount fee. This is calculated as the percentage of the invoice and ranges between 1.5 and 5%. This is often calculated on the funds advanced and on an annual rate. However, the fee is then charged on a weekly or monthly basis, given how the advance is tailored.

For example, the discount fee is 5% of the total invoice value. The invoice is raised for $100,000 with a 30-day term for every year. Hence, you’d be paying $410.95 for each term payment calculated as ((5000/365)x30).

The second critical factor to take note of is the service fee. This is defined as an administrative fee that the factoring provider charges for the range of services it manages for a client. This mostly ranges between 0.5 to .25% of the invoice value factored.

However, this again relies on a range of factors that have been explained below:

Size and Volume of the Transaction: High volume and size of an invoice transaction are inversely correlated with the factoring cost and fee charged. If a company is able to guarantee a high volume of invoices, the factoring company will charge them a lower service fee with a lower discount fee as well.
Industry: Factoring costs also depend upon the risk associated with an industry. The higher the risk factor, the higher the factoring and service costs. An example of this is the difference between the retail and healthcare industries. The former would fall under the high-risk category and the latter under the low-risk one. Subsequently, the factoring costs would waver.
Borrowers’ Credit History: A poor credit management history would ultimately lead to higher costs, whereas a healthy credit score would attract lower factoring costs.
Borrowers’ Customer Base: Factoring service providers may also consider a borrower’s customer rate. This includes how punctually a borrower receives payments on its outstanding bills.
Borrowers’ Payment Terms: Majorly, payment terms are factored in for 30 days. Hence, if a business has receivable days higher than that, the factoring costs would be relatively higher as well.
Borrowers’ History With the Factoring Service Provider: A history and a long-standing business relationship with the service providers can also affect the factoring cost.

Additionally, there are some other minor factors as well, which some service providers need to keep in mind:

Signing-up Fees: This can even be termed as a sign-up or application fee.
Credit Check Fees: This is to check the credit history of a borrower.
Late Payment Fees: This is applied in case of delay in payments made by the borrower.
Contract Termination Fees: Some factor providers can even charge a fee on the untimely termination of the factoring contract.

Disadvantages of IF

Besides the cost and rigidity of invoice factoring, there are some other factors that are disadvantageous to a borrower. The following list summarises the critical ones:

Dependency on Customers: The customer’s payment cycle stands as an eligibility criterion for invoice factoring. Hence, this makes a borrower dependent on its customers for reasonable factoring fees.
Lack of Control: Invoice factoring involves handing over total control of a borrower’s invoices to a factoring service provider. This, in turn, hands over critical financial information and control to a factoring service provider.
Cost: The fee bracket associated with invoice factoring ranges between 1-5%; this can be high for some borrowers.
Liability: A borrower may still be liable to handle unpaid bills.

Despite the minor drawbacks, it is evident that invoice factoring provides an alternative route to bank loans for short-term capital requirements. This eases access to finance by liquidating your receivables earlier than the expected date while delegating the responsibility to collect the dues as well. Moreover, the factoring fee varies on factors that the borrower can control, making the process more feasible.

How BridgeUp Can Help

Where factoring fees can be dependent on a lot of factors, a factoring service provider needs to be well-versed in the complexities of handling bulk invoices and managing them. This is where we bridge the gap.

We provide a tech-oriented solution to invoice management and factoring. With BridgeUp, you wouldn’t have to worry about a reasonable discounting fee, payment collection, or collateralization. To put it simply, BridgeUp provides a one-stop solution to all your invoice factoring needs with a robust infrastructure and tech-enabled platform to manage your invoices in an efficient way.

At BridgeUp, we ensure that your invoice factoring needs are tailored to your cash flow requirements with minimal hassle. We can guide you through the entire process of deciding a discounting rate to collecting payments from the customers. Sign up with BridgeUp now or call us at +91-9819660287 to manage your invoices better.

FAQs

When should your company use Invoice Factoring?

There is no straightforward answer to this but a suggested rule of thumb. If a borrower or a company has a bulk of invoices and their cash flow is suffering due to this, they should consider invoice factoring services.

How can BridgeUp help with your Invoice Factoring Needs?

BridgeUp provides a tech-enabled platform for managing and factoring invoices. Driven by experienced personnel, BridgeUp can offer you a seamless experience in managing your invoices.

What is the general rate of discounting?

It ranges between 1.5% and 5% of the invoice value.

What is the average time to qualify for the application?

It generally takes 2 to 7 business days to review and process the application.

How long does it take to get funded?

It usually takes up to 3 days to get funded.

What are the eligibility criteria for Invoice Factoring?

The basic eligibility criteria are as follows:

Your business should be categorized as either a B2B, B2C, or a B2G service provider
Your business should have a strong credit history.
Your business should not have any past legal or tax disputes.