As a spectacular alternative to loans, invoice factoring is a financial concept that allows a company to get operational funds by selling its invoices (receivables) to a factoring company. For this to work, you must be sure your debtors are reliable and be able to prove it to the factoring institution.
An invoice, in essence, is a financial document issued by a seller to a buyer, reflecting the items or service purchased, prices, and amounts; paid or outstanding. In monetary terms, a client’s invoice is the value of debt such a client (seller) is owed by 3rd party debtors (buyers).
Invoice factoring has proven itself to be a quick and available solution to periods of cash-crunch. Instead of taking a loan, entrepreneurs prefer to make their invoices work for them.
However there are some ‘danger zones’ to be weary of while engaging in invoice factoring, and here’s you’d get exposed to the top six.
1. Duplicate or fake invoicing
Oftentimes you may not be aware of this common error, in a bid to increase the value of your invoice and maximize funds, you submit the same invoice twice or submit a purchase order (which represents a service yet to be delivered) in place of an actual invoice.
The Factor may discover this in the long-run and come right back at you with heavy charges or worse. This certainly isn’t an entrepreneur’s dream.
2. Not being clear on maximum limit
The total amount of money you are privy to is usually established upon a successful invoice factoring. Many entrepreneurs are not aware; this information should be instantly given to them.
The possible pitfall here is that; you could end up with insufficient credits, at a time when you assume you have funds available to close a deal instantly. While you think your entire invoice had been liquidated, you might be taking other hidden charges from the factoring agency.
3. Being indifferent of factor-customer interactions
Yes, an invoice factoring contract authorizes a Factor to contact your customers to verify your invoices. However, you should have an idea of what goes on in that process. Being unaware could be detrimental to your business – customer relationships. This means you’d have to make some background research into the Factor’s customer service, so you won’t end up losing your customers later for the sake of having liquid cash now.
4. Overlooked business return policy
Some businesses do have a return policy for commodities sold to customers. If such a commodity gets returned, the corresponding invoice becomes invalid. This could cause a clap back from the factoring company if adequate information about your return policy and as well appropriate failsafe had not been put in place before engaging in an invoice factoring. To remedy this, proper client satisfaction should be considered before factoring their invoices. At the same, time invoices of commodities that still benefit your customer with a return policy should not be submitted for factoring until your customers’ time of return benefit has elapsed.
5. Lack of full understanding of contract terms
This could cause a variety of issues; an entrepreneur could easily fall into invoice financing and not invoice factoring for not having a full grasp of the contract being engaged.
Invoice financing simply is the use of your invoice as collateral in a loan, while invoice factoring is the instant liquidation of valuable invoices. Both processes require you to submit your receivables for cash, but the catch is deferent. In Invoice financing, you’d be paying interests, while factoring doesn’t have only requires you to pay interest when you have money withdrawn from your credits. Other common confusions exist, apart from that described above.
So there’s a need to be careful.
6. Poor exit plan
There has to be an organized process to quit the contract, this because some contracts don’t favor your long term business plans, therefore you should have a way to leave freely.
In a bid to reassure a Factor, entrepreneurs agree to an invoice factoring that lasts several years. This could really cripple the financial flexibility of your business. Therefore it’s better to stay safe and sharp by engaging in a one-year invoice factoring relationship.
If all the mistakes listed above are properly considered and avoided, your chances of a successful factoring experience increase several folds. It could also be helpful to go traditional, ask a neighbor who had undergone the invoice factoring process so you don’t end up with errors that go outside the scope of what has been discussed above.