How does invoice factoring work? - Invoice factoring is a way of getting cash for your unpaid invoices by selling them to a third party, usually a factoring company. The factoring company pays you a percentage of the invoice value upfront, and then collects the full payment from your customer. After that, they send you the remaining balance, minus their fees.
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Here is a simple example of how invoice factoring works:
- You have an invoice of $10,000 that is due in 60 days.
- You sell the invoice to a factoring company that offers you 90% advance rate and 3% factoring fee per month.
- The factoring company pays you $9,000 (90% of $10,000) within a few days.
- The factoring company collects $10,000 from your customer after 60 days.
- The factoring company sends you $700 (the remaining 10% of $10,000 minus 6% factoring fee for two months).
- You receive a total of $9,700 for your invoice, while the factoring company earns $300.
Invoice factoring can be a useful option for businesses that need quick cash flow and don’t want to wait for their customers to pay.
However, it also has some drawbacks, such as :
- You lose some control over your customer relationships, as the factoring company takes over the collection process.
- You may have to pay additional fees or penalties if your customer pays late or defaults on their invoice.
- You may have to sign a long-term contract with the factoring company or agree to sell a minimum amount of invoices per month.
- You may not qualify for invoice factoring if your customers have poor credit ratings or your invoices have long payment terms.