Invoice financing is an important way for a business to generate working capital, especially if they won't qualify for a bank line of credit. Although there is less red tape and an account is easier to set up than traditional financing, factors are very strong about verifying the validity of invoices. In a typical accounts receivable factoring relationship, the only security required is a assignment of the company's receivables. These are amounts callable from customers on goods sold or services actioned.
Depending on many factors, such as the type of industry the client participates in, the credit-worthiness of its clients, and the reliability of the firm's billing and collections process, the advance level on invoices submitted to the factoring provider can range from 65% to 85%. The remaining amount is declared the reserve and offers a cushion to the factor.
Why factoring companies need to prove invoices?
Since the factoring company's security is directly bounded to the amounts billed on credit, they will frequently contact the customers directly to examine the invoices. They will not only confirm the invoice totals, but equally as important, make sure the client is satisfied both in terms of completeness and quality.
Many businesses request factoring for a product or service that has yet to be provided in order to prop up their cash flow. Even though they have invoiced the customer, the work won't be done until later and the client needs to reinforce their cash flow. A company with this scenario isn't a candidate for factoring because the customer can demand their money back if the service isn't executed. This is called pre-claims. Another situation that doesn't fall into the model of factoring is progress billing.
This usually relates to a construction project in which the business bills the customer on a periodic basis until the project is completed. Because there is no milestone of finalisation, the factoring company is unable to advance monies on the invoice. To do so would massively magnify the risk to the factor. Another challenge is related to the warranty directly confined to the sale. If the customer is not satisfied with the goods or services sold, performance is called into question and there could be offsets against the invoice. In other words, not only do factoring companies require the work to be completed, they also seek to test the satisfaction of the client.
Ongoing issues of this nature will likely result in a termination of financing. Factoring can greatly improve the cash flow of an organization, but company principals and decision makers must understand the position of the factoring entity they are working with. There will not likely be a challenge if the goods or services sold are of good quality and credit is extended prudentially.
AR Cash Flow streamline small businesses cash flows by releasing the valuable cash tied up in invoices for immediate use in your business.