Invoice factoring is a popular alternative to traditional financing and it is a billion dollar industry with a large number of niche industries using it to get access to much needed cash flow, quickly and conveniently. With banks increasingly making it difficult (and in some cases freezing loans to small or new business) organizations and proprietors are partnering with professional factoring firms to solve their issues with liquidity. The concept of invoice factoring has remained the same throughout history and it has continued to play an important role in business finance. In the post economic recession banks are unwilling to lend to small businesses, which has made factoring a very popular option.
What is Invoice Factoring?
Invoice factoring is the option of using your accounts receivable income as collateral for a short term loan. Frequently the need for operational capital creates the need for an infusion of income in order to meet financial obligations. If a bank will not extend credit or if other financing options are not available a factoring company will conveniently allow the business to borrow against the value of incoming receivables to cover the shortfall and give the business access to net income sooner.
History of Invoice Factoring
4000 years – Factoring was first used in the day of King Hammurabi of Mesopotamia.
But, Factoring as we know it today got its start in the Middle Ages.
1300s and 1400s - Jewish businessmen fleeing persecution in Spain to Italy began lending money against the delivery and payment of grain shipped abroad and to distant trading ports. Merchants who solely bought and traded grain debt instead of the actually grain itself.
1600s and 1700s - By the time English colonists settled in America, this type of financing had become common with merchant bankers in London advancing funds to colonists for goods and materials before they made the journey across the ocean.
Fast Forward A Few Centuries
1910s – 1920s - The most popular industries for invoice factoring were the garment and textile industries. In order to make sure that companies could continue to buy raw materials to produce clothing and textiles, factoring was used.
1940s - United States almost wholly adopted non-notification factoring arrangements and witnessed a boom in factoring in textile industries and transportation industries.
1960s, 1970s and 1980s - Rising interest rates and bank regulations made invoice factoring more popular as it did not require the same sort of credit checks.
How Invoice Factoring Works?
Three Principal Characters in Invoice Factoring:
- Seller (one who sells receivables)
- Debtor (customer of the seller)
The receivable is essentially a financial asset associated with the debtor's liability to pay money owed to the seller (usually for work performed or goods sold).
- The seller sells one or more of its invoices (the receivables) at a discount to the third party, the specialized financial organization (aka the factor, to obtain cash.
- The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights associated with the receivables.
- The factor obtains the right to receive the payments made by the debtor for the invoice amount.
Benefits of Invoice Factoring for Small Businesses
- Invoice factoring benefits businesses who provide terms for their clients and are not paid for 30 to 90 days. Up to 90 percent of the value of receivables can be factored to assist businesses.
- Eliminates serous cash flow problems
- Factors evaluate the creditworthiness of the client’s customers and can fund within as little as 24 hours
- Invoice factoring companies can be a lifeline for new or small businesses who are not getting loans from banks