While there are many different business models, sometimes a growing business requires urgent cash flow and invoice factoring is one of the best options. It requires selling the invoices to a factoring company in return for immediate cash. The factoring company buys the invoices at a discount rate and then collects the bills directly from the customers. It is a type of finance option that is often used by companies that invoice their customers.
The money that the customer would have paid to the business is then transferred directly to the lending company. Opting for this finance option allows the company to receive majority of the payment instead of waiting for a long time for the customer to pay. This is especially helpful for new businesses. A startup will be able to continue its daily function like paying the employees or other utility bills without worrying about when the customer will make payments.
Sometimes waiting sixty or ninety days for an invoice can be detrimental for a company. It can not only halt operations for a small or medium sized company but also stop the business from getting new clients or customers. This is why a factoring company can keep the business in operation and in return make good profit on the investment.
Factoring based on recourse and non-recourse
While the idea of invoice factoring may sound simple, what if there are customers who refuse to pay. This is where factoring on recourse or non-recourse comes to play. If a business owner thinks that the customers are more likely to default on the payment then choosing a non-recourse lender is a better idea.
The lender will provide you with bad-debt protection but in return will be more expensive. This is because the lender is accepting a higher percentage of risk than a recourse factoring facility. This is used by many businesses that prefer to keep their business operational even in the instance of non-payment of invoices.
By choosing a non-recourse lender, the business owner ensures that the cost of non-payment is absorbed by the lender and does not affect the day to day operation of the business.
What makes it profitable: different rates and fee structures
Factoring is similar to taking a business loan but the costs and rates are different from the usual credit. It has become popular recently because it is an innovative way of taking credit and comes with fewer complications. Instead of a monthly payment which is a traditional way of reimbursing credit, here the business has to pay a fee. The amount depends on the amount of work generated towards the lender. This is calculated as a service fee.
Beside this fee there is also a discount rate. This is applied on the month’s invoice and this is the amount that has to be paid to the factoring agency or lender. The discount rate goes down if the business has less instances of late payments or bad debts