Your business is in a bind because purchase orders keep coming in that need to be supplied, but your cash flow is stagnant. Instead of waiting for your customers to pay their invoices, there are a couple of ways you can use their balances to get cash immediately: invoice factoring or accounts receivable financing.
The fundamental trait of invoice factoring is that it is an outright purchase, generally around 80%, of your outstanding debt ledger. The factoring company will typically take complete control of the debt and collect directly from your customers. Since absorbing the loss of bad debt invoices is riskier, the fees are often higher than similar financing solutions.
You may consider it a benefit that the purchasing company will often take over invoice management, but keep in mind that you now have no control over how they deal with your customers or what collection methods they use. This could potentially damage existing relationships and lead to future problems as you almost surely will have to negotiate with your customers down the line. Also, this option is usually only available for billing within your borders; international customers might preclude you from invoice factoring.
Accounts Receivable Financing
Accounts receivable (AR) financing offers your company cash upfront in the form of a loan up to the full value of your AR balance, which is then repaid by collections. Your AR liability will become collateral, and you retain ownership of the money due. Since the loan is secured, the financing rates tend to be much lower than the fees involved with invoice factoring.
Many companies that offer AR financing also can work with different currencies and areas, widening the availability to businesses with international customers. Your company will generally maintain control of invoice collection and keep the face of your relationship with your customer, so you are free to handle negotiation in whatever way you feel will strengthen your rapport.
As the invoices remain outstanding, the lender will generally charge a recurring fee, although this could incentivize your collections department to pursue payments in earnest. If debts are collected early, you often have the choice to pay the loan off sooner with no financial recourse. However, if the customer refuses to pay the invoice, you will be responsible for clearing the debt with the financing company.
As with most financing options, there are pros and cons to both invoice factoring and accounts receivable financing. It will be up to you to weigh them carefully and decide which is the best solution for your business. But if you are in a bind with your cash flow, these are two possibilities for getting the funds you need to keep your company moving forward.