What is Invoice Factoring?Perhaps the term factoring immediately brings to mind grade-school attempts at mathematics concepts that may have felt to you like a foreign language–hours of struggling at the kitchen table, pouring over numbers with parents who threw up their hands in frustration. Lucky for you, when we talk about factoring, we mean something else entirely. Although it may initially feel no less unfamiliar, it probably involves less math, less hand throwing, and–even better–more cash.
For our purposes, factoring simply refers to a company purchasing debt by way of an invoice. Although there are many intricacies within the discussion of factoring, at its most basic level, it is a way to increase cash flow by exporting invoices to another company called a factor. They give you the cash for your invoices (minus their fee) within a few days, instead of standard payment terms of 30 days or more.
A deeper dive
When you think of factoring as just another type of financing, it begins to make more sense. For smaller or even new businesses, factoring can act as a type of financing that may otherwise be difficult to obtain. When you factor, you aren’t borrowing money, but accessing your own on an improved time schedule, reducing back-office paperwork, and eliminating collection calls.
Practically, factoring is accomplished by partnering with a company like Sekady, which purchases your unpaid invoices and releases the funds to you the next business day. You’ve got cash in hand and working capital, less paperwork, and no collection calls to make.
Our process is simple–you complete a work order, send your invoice, receive electronic payment the next day for a small fee, and finally, your client pays us. The practice of factoring simply outsources the dirty work of collecting an invoice to a company that specializes in it, leaving you free to tend to the business of your business.
The origins of factoring
The word factoring comes from the Latin word facere. For as long as people have been exchanging money for goods and services, some form of factoring has likely existed. In ancient Rome, merchants hired individuals to manage parts of their business, including the collection of debts. Through the Middle Ages, such practices continued, and as colonization began and goods were exported with increasing frequency, practices like factoring happened more and more.
In the 19th century, European goods were in high demand, which forced suppliers to keep inventory on hand. In these instances, factoring meant that the factor held and stored the goods, found buyers, delivered the product, and eventually collected payment. The factor earned a commission based on the value of the product sold, handing over profit beyond that to the owner.
Eventually, factors shifted from the consignment model, particularly in America, where technology made it possible to sell products directly to consumers, often with the help of books or samples. Changing needs made factors resemble what we see today in which products were not held.
In 1960, what would become the FCI appeared–a group of factors and banks from Finland, Denmark, Norway, United Kingdom, Sweden, and the United States joined in a federation. By 1968, FCI–Factors Chain International–consisted of 15 companies from 12 countries. Now, the FCI has 400 members in 90 countries, which helped transform factoring into a practice viewed as safe, secure, and useful to business growth.
What industries use factoring?
Factoring happens across industries, although it is particularly helpful in situations where improved cash flow is needed to pay employees, bills, or pay for growth. From staffing to courier services and security guard services to landscaping, factoring offers a unique and simple way to put cash in hand. A few of the industries that benefit the most from invoice factoring include:
Apparel
There is a lot of competition in the apparel industry, which means adequate cash flow is imperative to business success. To fulfill existing orders, a business owner must be able to purchase inventory. If there is any sort of delay or a lapse in orders, this can lead apparel businesses into a vicious cycle in which they can’t accept new orders because they’re waiting on payment for old orders, which funds inventory. Factoring helps businesses in the apparel industry maintain a sales cycle that works for everyone, fulfilling orders in a timely and intelligent way.
Technology
Technology companies operate in a highly competitive market that is quickly changing, which makes them a good candidate for the quick cash that factoring invoices can help provide. Finding and keeping good people employed in this industry can also be a challenge, so having the cash on hand to mitigate potential outside job offers with a bonus or raise can be beneficial, especially because you’re not borrowing money, simply getting a hold of yours in a more timely way.
Transportation
Trucking and transportation frequently utilize factoring because of the nature of their business. Freight invoices are plentiful, which means that managing them can be a hassle. By factoring invoices, they ensure that payments happen on time, even if other things don’t. Factoring provides for payments for drivers, gas, repairs, etc.
Manufacturing
Manufacturers deal with a lot of invoices, which makes them ideal candidates for invoice factoring. Business can’t stop because of outstanding debt, but incurring extra debt by way of loans isn’t a great business practice. Manufacturing is a business that requires a decent amount of working capital, can incur costly repairs, and employs many people, which makes factoring a logical choice.
Construction
Companies that work in all areas of construction are excellent candidates for invoice factoring because of the number of general contractors and subcontractors they’re dealing with every day. The industry has an increased need for flexible capital and a high number of invoices because of the number of people involved. From roofing to utilities to concrete to demolition, factoring helps the invoice process go smoothly.
Of course, the number of industries that use and benefit from factoring is nearly endless. In today’s world, in which many businesses are strapped for employees and in need of working capital, factoring helps outsource what is, for many, an unpleasant part of the job. While some factors specialize in the industry they work with, many are open to working with businesses across all industries because the process remains relatively consistent–the factor purchases your invoices, your funds are released the next business day, and you’re ready to use the money as you wish, free from the lengthy process of debt collection.
Benefits of factoring
Unlike other types of financing, factoring invoices doesn’t require credit scores, collateral, or loan history, instead offering fast cash without some of the risks. While there are many benefits, some of the most significant include:
Flexibility
It can be hard to plan for your business if you don’t know exactly how much money is coming in and at what time. Invoice factoring allows you the peace of mind of not depending upon those payments since your factor pays you directly. This way, you’ve got predictable cash flow whenever you need it.
Some companies choose to use factoring as a one-time solution for temporary financing, but many find the simplicity to be a good fit for every invoice cycle.
Time
Factoring gives you your time back. By outsourcing the arduous task of invoicing and collections, you’ve got more time on your hands to do the work people are paying you for–or take a vacation! Not only do you get to spend the time you’d spend processing invoices on other things, but you get to do it with cash in hand.
Also, when you factor your invoices, you get the money almost immediately. When you take out a loan from a financial institution, it is a lengthy process–and you usually owe interest.
Better relationships with customers
Anytime you have to invoice a client, there is a risk that they won’t pay. Debt collection isn’t a fun task for anyone, but it can be particularly problematic when you have relationships with your customers that may need protecting. This is especially true for small businesses in which more direct communication occurs. By using a factor, you turn the responsibility of collecting money over to someone else, which ensures you maintain a positive relationship with your clients, building lifelong loyalty.
The bottom line
Factoring, underneath all the jargon, is a relatively straightforward process, especially if you’re working with the right company. By working with a company that specializes in your industry, you can ensure access to the best possible range of solutions to meet your needs. Not all companies are created equal, so make sure to do your research and find one that is a great fit for you.
Sekady offers business finance solutions of many varieties, and we’d love to work with you to develop a personalized plan that gives you what you need to grow. For more information, fill out our contact form or give us a call at 208.452.1910!