It is not possible for any large organization to pay their suppliers, vendors, or any associated parties upfront. The reason being the internal validation of the invoice value post review of the shipment received. This is why businesses run on credit.
Ideally, when an organization receives an invoice, it is transferred to the accounts payable department. This entire process of clearing the invoice can take upto 95 days with zero faults in between.
On the other hand, the suppliers who have provided the shipment firsthand have to wait for upto 95 days to get their payment. However, even they need to run their operations, pay their employees, and purchase raw material for shipment. It means in spite of having a trade agreement with the organization, the supplier is still at a disadvantage.
To mitigate this, there are several options the supplier can choose. Firstly, they might go for a bank loan which is difficult to get and is expensive. Secondly, they might go for a term loan but it requires a good credit history and lastly, they might think of going for invoice factoring.
What is Invoice Factoring?
In a simpler term, it can be assessed as selling invoices at a discounted price . The transaction occurs between a supplier and a lender or an invoice factoring company. In majority factoring services, the invoice factoring company will be responsible for getting the cash for the debt. An invoice factoring will contact the debtor after the term of 95 days to collect the debt. They may also take legal action if there is an issue of non-repayment. Usually, invoice factoring company’s exchange rate can range from 80% to 90% of the total invoice value depending upon the risk involved.
Invoice Factoring Example
Let’s take the example of a cupcake company. To make cupcakes, the cupcake company would require certain ingredients such as flour, sugar, eggs, etc. The cupcake company would create a purchase request of buying flour from the supplier with a repayment term of 60 days. Here, the cupcake company gets the flour upfront but the flour supplier will be left without payment for the next 60 days.
Using invoice factoring, the flour supplier will sell his invoice to a factoring company at 90% value of the invoice. Let’s say the value of the invoice was $1000. This means the supplier would get $100 less for its flour but he’ll get the money upfront to run his operations. On the contrary, the invoice factoring company would make $100 on the invoice.
It is profitable to both parties because the supplier may be making $1000 worth of flour at the cost of $600 and still get money upfront. On the other hand, the invoice factoring had to wait for 60 more days to get the invoice’s value but ended up making $100 in the transaction.
Types of Invoice Factoring
Some frequently used types of invoice factoring include-
- Recourse Factoring: Commission charges with this type of invoice factoring are low because of low risk. In this, the factor only provides immediate cash without collecting debt, thereby, no protection from credit risk. Instead the supplier itself is liable for it.
- Non-Recourse Factoring: It is the type of invoice factoring that provides protection from credit risk, therefore, the commission is also high.
- Advance Factoring: In this the amount of invoice is paid in advance by the factoring company minus the commission and the margin. The commission can range anywhere from 5% to 25%.
- Maturity Factoring: In this type of factoring, the commission to the company is paid post the payment of the invoice by the customer. Here the factoring company is primarily responsible for collecting the debt from the customer.
- Bank Participation Factoring: It is ideal for small businesses for whom even the smallest margin matters. In this type of factoring even the margin of a factor is financed by the bank.
- Full Factoring: It is the type of factoring where the factoring company provides all the services associated with invoice factoring such as protection from bad debt, collection, advance payment, etc.
- Domestic and Cross-Border Factoring: Factoring service provided locally is considered as domestic factoring. It primarily involves three parties that are buyer, seller, and the factor. In cross-border factoring, the service is provided by an international party. It involves four parties which are exporter, importer, export factor, and import factor.
- Supplier Guarantee Factoring: In this type of factoring, the factor provides a guarantee to the supplier for payment.
- Disclosed and Undisclosed Factoring: Ideally, the client of the business is aware that a factoring company is involved in the payment. This is known as disclosed factoring. On the contrary, when the client is not aware of the same, it is considered as undisclosed factoring.
Key Benefits of Invoice Factoring for Securing Cash Flow
The core purpose of invoice factoring is to reduce credit risk and secure cash flow. Below are some of the benefits associated with invoice factoring:
Maintain Cash Flow
Suppliers are in immediate need of money to expand their inventory and serve their customers. There are other options for getting money such as business loans, overdrafting, venture capitalist, etc. Yet, each of these comes with their own set of challenges such as extended time of approval, requirement of collateral, or stake in the business. With invoice factoring, the cash flow is immediate and the supplier only requires a legible invoice which will be paid by the customer.
Invoice factoring takes away the task of collecting the debt from the customer. This helps businesses to primarily focus on core operations, thereby, helping them expand & sustain in the market.
Businesses often require flexibility with cash flow. With other options available, it is not always possible but with invoice factoring it is almost immediate once an invoice has been received. This allows the business to expand and get instant invoice factoring money by taking a little suffering on the overall margin.
Higher Approvals for Finance
Financing using other options require some form of credibility such as credit score, collateral, financial history, etc. On the other hand, a factoring company will check the supplier’s client payment history to assess the risk. Based on this assessment, the commission is calculated. Also, if the supplier’s client is consistent with payment then these rates of commission get lower after a point of time.
No Collateral Required
Invoice factoring doesn’t require any collateral. Instead, it only demands the invoice at hand that is to be paid by the customer.
A lot of businesses use their current account for conducting operations. Oftentimes, the business would end-up spending more money that is available in their account. In this scenario, invoice factoring gives the comfort of dealing with overdue bills by providing financial flexibility to expand the business and bridge the financial gap.
Better Customer Relationships
It lubricates the active to and fro relationship of financial transactions between the customer and the supplier. With invoice factoring, the customer gets the due time to get the invoices approved by the AP department. On the other hand, the supplier gets the money upfront to run the operations without any financial setback.
Documentation Challenges Associated with Invoice Factoring?
In order to establish the credibility of a supplier demanding factoring, invoice factoring companies require a set of documents that needs to be verified. These documents are address & identity proof for KYC, account receivable ledgers, bank statements, and financial statements. These documents are submitted one time but contribute work for supplier onboarding.
On the other hand, the invoice factoring company faces a much bigger problem of invoice processing. The task of invoice processing needs to be spontaneous because the whole idea of factoring is to provide the money upfront. The ordeal goes through a major fallback when there are tons of invoices to process. With manual processing and traditional methods, it is not possible to process those invoices without making errors like incorrect data, lost data, duplicate data, etc. Also, the sheer number of unstructured invoices from varied sources makes it difficult for the AP department of the invoice factoring company to extract data and validate it beforehand.
Also while providing advances to the supplier, the factor company goes through certain documentation such as accounts report, backup documentation, invoice copy, etc. It calls for a smart solution like an IDP platform that can automate the entire ordeal of document processing as well as invoice processing.
How can IDP help with Securing Cash Flow for your Company Expansion?
In a report by Grandviewresearch, the global factoring market was valued at $3235.88 billion in 2020. Also, a consistent CAGR (compound annual growth rate) of 8.5% is expected between 2021 to 2028. It means the invoice factoring market is bound to grow. Also as reported by Billentis, the amount of invoice processes in the year 2019 was 55 billion. It is a huge number and with the growing entrepreneurial spirit, the expected number will grow because new suppliers are constantly resurfacing the marketing. Each of these trends points towards new business opportunities for factoring companies, therefore, it becomes collateral that they bring automation solutions to fasten their process. It is because in the emerging competing market, an invoice factoring company’s repo would be tied to the sheer volume of instant payments they provide to the suppliers. To achieve that they need to fasten their internal verification and approval process.
With an IDP platform, invoice factoring companies will be able to extract data and verify data without any fallback automatically. The system requires zero manual intervention, therefore, the turnaround time for completing multiple financial transactions would be reduced exponentially.
What is an IDP Platform?
An IDP platform is a document processing AI-based solution that is capable of extracting custom data and verifying it automatically for huge volumes of documents. The user only needs to provide the batch file and assign the source of truth. Using the provided data, the IDP platform can verify documents without any manual intervention. It also reduces the operational cost of document processing by a large margin.
Suppose, there is a task of extracting and verifying data for 1000 invoices. As a source of truth, the invoice factoring company is using the supplier’s trade name and GST number. An IDP will require the batch file of the invoices and the archived file for existing supplier’s database and GST certificates. An IDP platform would automatically verify the data and the transactions for which the data is not available, it will raise a flag. The invoice factoring company would also be able to extract data from custom fields from the invoices. This data can be easily exported in the format of excel sheets or CSV files.
How can VisionERA be the trusted platform to improve Invoice Factoring?
VisionERA is a new generation IDP platform that is capable of extracting and verifying data at the speed of light. It is backed by advanced proprietary technologies like Artificial intelligence (AI), Machine learning (ML), Natural language processing (NLP), and Computer vision that provides it with exceptional accuracy and automation level.
It is an industry and use case agnostic solution that can fit the need for any type of invoice factoring document processing needs. It stands out with its compelling features that enable Human-AI alliance. VisionERA is a one stop solution that is capable of processing huge volumes of unstructured documents with a custom DIY workflow. It offers groundbreaking features like field autocorrection, automatic gridling, industry beating table detection system, etc.
Its continuous learning feedback loop mechanism makes it an ever evolving platform. With its advanced learning and evolving mechanism, it is a document processing solution capable of running in auto-pilot. It requires zero-pre training unlike many of its contemporaries and it allows effective categorization of data as the final output.
In the modern-day business, invoice factoring is a boon to suppliers trying to run their businesses and keep pace with the ever-evolving market. It allows independence from financial setbacks and empower businesses to walk on new and larger avenues. Therefore, it becomes important that invoice factoring companies strengthen their internal processes by utilizing automation solutions like IDP. This will help them provide better service to the businesses lending money to them and give factoring companies better footing in the emerging market.
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