It is a problem every business owner knows all too well. It prevents growth, thwarts progress, and slows business to a grinding halt. Whether you have a startup or are celebrating 50 years in business, you have experienced the pain of unpaid invoices.
Businesses need income ― in fact, it is the purpose of businesses to generate money. However, when invoices become delinquent and clients are late to pay, businesses cannot obtain the income they desperately need. No matter how straightforward your invoicing process, you will always have a few clients who disappear without leaving so much as a dime. Thankfully, you don’t have to sacrifice your business over a few slow-paying clients; you can rely on invoice financing, instead.
What Invoice Financing Is
The service goes by a few names ― invoice financing, invoice factoring, and debtor financing are the most common. No matter what you call it, the basics remain the same: Instead of wallowing in unpaid invoices, you can sell your unpaid invoices at a discount to a third party.
Essentially, there are three participants involved in the proceedings. Most importantly, there is the business with unpaid invoices, or you. There is the debtor, or your late-paying client. Finally, there is the factor, or the third-party financing provider that purchases the debtor’s invoices from you.
Your invoices are inherently valuable financial assets, even if they are currently preventing your business from blossoming. Therefore, the factor has a financial incentive to acquire your invoices. However, because the invoices you are selling are currently a financial liability, you cannot sell them for more than their worth; in fact, most factors impose a discount.
Still, for most businesses, incurring the discount to get access to money immediately is more favorable than the alternative: spending unknown time and resources tracking down the debtors and forcing them to pay. Ultimately, you end the exchange with cash in hand.
In disclosed sales, the debtor is notified of the factored invoice, and the factors themselves are responsible for collecting on unpaid debts. However, in the event the debtor continues to refuse to pay, you should be aware of the sale’s terms of recourse. “Without recourse” means a factor takes a loss in the event the debtor cannot or will not pay; “with recourse” means your business is accountable for making those payments after a certain time period.
Conversely, in confidential sales, you retain the responsibility of collecting the debt on the factor’s behalf. This might be preferable if you wish to retain your clients, even the delinquent ones, and are concerned that a factor might be aggressive when it comes to collecting from the slow-paying client.
Generally, invoice financing is a smart business move. Though businesses lose a small portion of income to factors’ fees and interest, they do receive the money they need to grow. Without invoice financing, most businesses must take a loss on delinquent payments because they lack the time and resources to pursue their debtors.
Where Invoice Factoring Comes From
The first account we have of invoice financing dates back 4,000 years to Mesopotamia, where King Hammurabi laid rules regarding debt collections. However, our modern sense of the service is more closely related to a practice that developed in the High Middle Ages in Europe. Fleeing persecution and unable to obtain typical work due to prejudice, Jewish merchants began buying and selling debt based on grain shipments. By the 18th century, the practice was so common that gentiles established their own debt collections agencies.
Fast forwarding to the 20th century, the textiles and garment industries were the most popular users of invoice financing because the process allowed businesses to constantly have cash to buy raw materials. While the economy boomed after the world wars, interest rates and bank regulations made it more and more difficult to secure a traditional loan, allowing invoice financing to become exceedingly popular because it does not require credit checks from any party.
Today as always, businesses hope to make money, and invoice financing providers want to help them do just that. If you want to avoid drowning in unpaid invoices, a factor is a reliable life boat. You can find responsible invoice financing providers a number of ways, such as asking an allied business for suggestions or searching the Better Business Bureau (or other online B2B service providers). As long as you read and understand the terms of the deal, you should have the cash your business needs in no time.