Invoice discounting can be used to create a steady cash flow for a company. It uses unpaid debt owed to a business as collateral for cash flow in a revolving manner. Generally, a business can borrow 70-90% of unpaid invoices. The company would simply turn the invoices over to their discounter, and the percentage agreed upon would be deposited into your account. When the invoice is paid by the customer, the money borrowed is repaid and the discounter collects their rate and fee. What’s left over is returned to the company. Even better, customers never need to know about it. It’s confidential and allows your business to maintain control over its invoices and credit control systems. Rates are usually reasonable, ranging from three to seven percent.
Invoice factoring is essentially the same idea, except the financier manages your sales ledger and collects debt on your behalf in addition to allowing your business to draw against that debt the way invoice discounting does. Typically a larger business or a B2B would be a better fit for factoring, and invoice discounting fits smaller business’s needs. Some financiers will only buy commercial invoices, so be sure to ask what types of invoices the financier(s) you speak with are willing to purchase.
Criteria that factors and discounters consider are:
- Capacity of invoices to be factored
- Average size of invoices
- Your normal payment cycle
- Amount and types of customers
- Credit risk of customers
When it comes to factoring remember:
Personal communication with customers is important, even during the process of collecting on an invoice. Any time you can connect with a customer is highly valuable. That is why it is essential to consider how your customers would react to a change in a system that is already established. It is critical to pay attention to how your financier treats other people around them. You want a company that prides themselves on customer service-how they treat your customers when you’re not around can undo a lot of hard work. Taking your time to find the right company with the right ethics in this matter is one of the most important things you can do when considering factoring.
Recourse and Non-Recourse Factoring
Recourse and non-recourse factoring refer to two ways to deal with an invoice that goes unpaid during factoring. Recourse means the company is going to assume responsibility for all unpaid debts, not the financier. Non-Recourse Factoring means that the financier legally takes ownership of all unpaid debt. This leaves a business with one less thing on their mind, but it also means you’ll pay higher rates and fees, as the financier is assuming higher risk. The financier will also set strict credit limits due to this version of recourse.