There are a number of ways in which businesses can improve their cashflow. Invoice factoring remains a popular solution for many B2B companies. But what is invoice factoring and which type is right for your business?
How Factoring Works in B2B A/R
Deployed in the right situations, factoring gives suppliers an immediate bump in cashflow that can prove crucial in funding operations and growth initiatives.
Factoring is a way to collateralise accounts receivable (A/R) or, in certain cases, another current asset such as retail inventory.
With AR/invoice factoring, a supplier sells its unpaid invoices to a third party factoring company. In return, the supplier receives what amounts to a cash advance of usually about 90% of the value of the invoice.
The remaining value (10% in this case) is paid by the factoring company to the supplier once the buyer pays the invoice to the factoring company. The factoring company also charges the supplier a factoring fee for this service.
There are two types of factoring; recourse and non-recourse. Recourse factoring is the most common.
This is when the supplier guarantees to buy back any of the accounts receivable it sold to the factoring company that remain unpaid past their due date or are in dispute.
Since the supplier remains liable for unpaid invoices under a recourse factoring arrangement, the factoring company may offer higher cash advance rates and lower factoring fees.
The factoring company may also take a more rigorous look at the creditworthiness of the B2B supplier selling it the invoices.
Non-recourse factoring is when the factoring company takes on the credit risk and liability for unpaid invoices.
For taking on that risk, the factoring company will charge a higher fee, offer lower cash advances, and be more selective in choosing which invoices it buys.
When invoice factoring works smoothly, it results in buyers paying invoices according to their preferred terms and suppliers getting paid (most of the invoice) quicker. The process is smooth and efficient with a positive customer experience.
There are important considerations when evaluating whether to deploy factoring. Keep in mind that:
- Factoring is a highly manual activity: A number of decisions need to be made based on interrelated variables. For example, a non-recourse factoring arrangement may result in you paying higher fees.
Also, factoring companies typically need to manually verify an invoice after it has been submitted. That process is rarely, if ever, entirely digital. A human often has to reach out to the buyer to verify the expense. And routing the payment to the supplier may or may not be a digital process.
- Factoring adds a third party to your buyer’s customer experience: Buyers need to be informed that the process has changed; sometimes the use of a factoring company can raise questions among buyers about the supplier’s financial stability.
When payment submission errors arise, buyers are involved in correcting those errors, which adds friction to the payments process and can tarnish the customer experience.
Factoring is often a short-term and expensive solution to a common problem.
But looking more broadly, there are alternatives solutions that optimise your working capital while also offering additional benefits that help encourage higher customer spending and loyalty.
The concept of embedded payments in B2B transactions has become a hot topic in the past couple of years.
The TreviPay solution includes a cost-effective alternative to factoring with the ability for you to offer a line of credit to your B2B buyers. As this credit is underwritten by TreviPay, the liability for the credit as well as the responsibility for unpaid invoices are no longer yours.
Assessing creditworthiness, customer onboarding, managing the customer experience and process efficiency are all critical to business performance and customer relationships.
TreviPay enables you to optimise and embed these into your processes to make your commercial terms more flexible and your business a preferred supplier.