At some point, every business encounters problems with cash flow. This issue particularly effects growing businesses, and businesses whose customers are slow to pay their invoices. A solution to fix this? Invoice factoring—an efficient process to improve your cash flow in a sustainable way.
Are you a business owner seeking to improve your accounting procedures as well as increase your working capital? Invoice factoring may be of interest to you! The process involves transferring invoices that you have already issued to your customers to the bank, in exchange for immediate payment of the invoices by the bank. The bank will also finance your accounts receivable, transferring your sales revenue more quickly into your bank account.
Invoice factoring is, above all, a short-term financing solution, but can be used on a regular basis. It is a complementary operation to other financing solutions offered and can replace a line of credit by allowing the company to monetize its different accounts receivable.
A business that transfers its invoices to the bank through an invoice factoring contract gets three advantages:
Long associated with an image of unstable or struggling businesses, invoice factoring is today largely used by businesses of all sizes, across many fields—provided that the clients are businesses, since amounts invoiced by individuals are not eligible for this service.
Depending on what situation your business is in, it could be appropriate to use invoice factoring.
In certain industries, customers can request lengthy payment deadlines, while suppliers demand payment more quickly. This can significantly impact the cash flow of a business, i.e., all the liquid assets owned. Invoice factoring allows you to better harmonize the timing of cash inflow and outflow.
To obtain new service contracts, or to produce products in advance that customers will request, a business must spend money now (on hiring, purchasing materials and raw materials and paying subcontractors), while their customers will pay later. The more quickly a business grows, the more it will need considerable working capital. Invoice factoring can give the business room to breathe and expand.
In a highly competitive market, a business must find a way to set itself apart from others and offer clients particularly attractive payment options. If a business does not have the solid cash flow to do so, invoice factoring can provide the financial flexibility necessary to accept longer payment deadlines.
If the sales of a manufacturing or distribution business are concentrated during a few months out of the year, the business must often manage a lot of stock during the rest of the year, because it cannot produce or acquire all its products... until right before selling them. Storage costs can be considerable. By using invoice factoring, the business becomes less dependent on payment deadlines for its customers. It can therefore agree to longer payment deadlines to encourage them to get ahead of their purchases and therefore reduce the amount of stock to manage during periods of low demand.
Certain larger suppliers can offer particularly attractive discounts for quick payment, but the business cannot benefit from this because it does not receive payment from customers as quickly. By monetizing its accounts receivable to improve cash flow, invoice factoring can allow the business to pay certain suppliers more quickly to benefit from their discounts.
Unlike loans and lines of credit, the amounts received in exchange for receivables transferred from the business are not considered a debt for the business. The use of invoice factoring does not negatively affect the financial structure of the business. There is no risk of defaulting on certain financial ratios that the business must meet.
When major changes are made to the structure of a business—as a reaction to an external impact or after an acquisition, for example—the business can easily lose control of its cash flow because it must manage its current operations more. In such a situation, invoice factoring can stabilize cash flow. The financial direction of the business can then focus on restructuring without being distracting by a short-term lack of cash flow.
Invoice factoring can be considered outsourcing the financial management of accounts receivable. Internally, this management can cause issues and create stress if the systems or human resources assigned to the process are not effective. Invoice factoring is a way of giving the management work to a specialized supplier.
When a business creates an invoice in foreign currency, it takes on any risks related to the fluctuation of the currency exchange rate against the Canadian dollar between the billing date and when a payment is received. If the exchange rate falls during this time, the company receives less than expected. Invoice factoring counters this risk by providing quick payment in Canadian dollars before the exchange rate has had time to fluctuate.
Invoice factoring alone does not solve all cash flow problems within a business. To benefit from invoice factoring, the customers of the business must be solvent. Also, the cost of invoice factoring must be evaluated according to the financial benefits it provides.
For many businesses, selling its invoices to the bank can be a useful complement to other financial tools. In many cases, invoice factoring can play a strategic role in facilitating the business’s day-to-day operations, improving its offer for its customers and potentially making the business more profitable in the long term.
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