Invoicing Methods And Factoring
Keywords: invoice factoring, accounts receivable factoring, working capital, cash flow, receivables funding
If you are considering using accounts receivable factoring as a financing tool, you should carefully consider the type of billing arrangement you have with your customers. Invoice factoring relies on important considerations concerning your business model that could make it easier to get funding.
When you initially set up your agreement with the customer, you should specifically outline the work to create deliverables or milestones that allow you to invoice. By setting these milestones, the customer is obligated to pay for the work to that point and you can generate an invoice for that part of the goods or services. Contrast this scenario to progress billings, an arrangement in which the customer advances money for the job as a whole. The factor is hesitant to advance funds to the client with progress billings, since the company getting billed may become unhappy along the way and stop making payments. With milestones, on the other hand, that is not a problem.
Pre-billing for services is another example of a problem for factoring invoices. Common to the publishing and advertising industries, the customer is invoiced for a publication that will run in the future. From a factoring standpoint, proceeds of the obligation are assigned to a third party. If the work has not been satisfactorily completed, the customer likely will not pay the entire amount, if at all because there are too many “outs”. The factoring company has advanced a significant amount of funds up front, so they are left holding the bag when the customer refuses to pay. In this situation, the factoring company will almost assuredly adopt recourse factoring. This means that if the customer doesn’t pay the client the full amount that was invoiced, the factoring company can collect the money that was advanced.
Many business owners might not understand why factoring companies would take such a strong stand with both pre-billing and progress billing situations, especially since factoring is admittedly an expensive form of financing. Factors make their money by the spread between their own credit lines and those they extend to customers. It doesn’t take too many “hits” from non-paying customers to wipe out profits. Therefore, factoring companies must have a cushion to prevent non-paying accounts.
Even if you don’t need to factor your invoices, it is usually better to structure your invoicing in such a way that the customer is obligated to pay during each step in the process. This gives both you and the factoring company some piece of mind that the customer isn’t likely to walk away. The milestone arrangement is the best way to accomplish this goal.
Kent Harlan has been a CPA since 1984 and is the owner of Ozarks Capital Funding, a Missouri-based company offering financing in the areas of accounts receivable factoring, equipment leasing, asset based lending, and financing for healthcare providers.
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