Cash flow issues or a shortage of funds in any industry most commonly depend on its normal cash flow cycle. In manufacturing, these cycles tend to be lengthy. That is because manufacturers must start production, buy raw materials from suppliers, operate machinery and pay workers, all before receiving payment from their customers. This gap between production and invoicing can cause manufacturers to deal with significant cash flow issues.
To manage these cash challenges, many financial solutions are available. In this blog, we focus on invoice factoring as a way to address manufacturers’ slow financial cycles. We will explore how it works, its advantages, possible disadvantages and cost implications.
What is invoice factoring for manufacturing?
With invoice factoring (also called debt factoring), manufacturers can sell their unpaid invoices to a third-party factoring company immediately after issuing them. The factoring company buys these invoices and issues a cash advance against them to the manufacturer. This immediate payment is a 70% – 90% portion of the total invoice value and can be availed within 24 hours. In return for this service, the factoring company charges an invoice factoring fee, which is deducted from the rest 10% – 30% of the invoice value, once the customer pays the full amount.
Cost of manufacturing invoice factoring
In invoice factoring, a fee of 1% – 5% of the total invoice value is charged to the manufacturer. A higher factoring fee means more risk associated with your factored invoices and vice versa.
The invoice factoring costs for manufacturers depend on the following factors:
- The average cash cycle of your business sector, manufacturing in this case.
- The creditworthiness of your clients.
- Length of invoices factored.
- The number of invoices factored.
- Past average sales revenue brought in by the business.
Let’s explore how the process works in detail, from start to finish.
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How does manufacturing invoice factoring work?
The process of invoice factoring starts as soon as a manufacturer provides services or products to a business, and a contract is formed. Here are the steps which take place during the process:
Step 1
The manufacturer issues an invoice to the customer after delivering the agreed-upon services or goods. The invoices must represent completed deliveries (not accepted if the customer is still waiting for their service).
Step 2
The manufacturer contacts a factoring company to sell its invoices. The number of invoices factored depends on both the manufacturer’s will and the factoring company’s policy. Some companies offer single invoice factoring, where as little as one invoice can be factored. It is also commonly known as spot factoring. Others might only work with manufacturers who factor more than one invoice or a major portion of their sales ledger.
Step 3
The factoring company reviews the invoices against their invoice number and verifies them to carry out a formal evaluation process.
Step 4
After the invoices are validated, the factoring company issues advances of 70% – 90% of the invoice value to the manufacturer. A factoring fee is also charged, which ranges from 1% -5% of the total invoice sum.
Step 5
The factoring company then takes charge of the invoice collection process from the manufacturer’s original customers and other administrative work. This removes the burden of chasing payments and reduces the cost of following up with them.
Step 6
Once the clients have fully paid their invoices, the factoring company releases the remaining 10% – 30% invoice value, after deducting the factoring fee.
Step 7
In case of non-payment, responsibility depends on the type of factoring agreement, whether it’s recourse or non-recourse. The factoring company bears the loss in case of non-recourse factoring. However, if the factoring agreement is recourse, the manufacturer absorbs the liability for the unpaid invoice.
Manufacturing invoice factoring vs financing
Invoice discounting, or invoice financing, is another type of invoice-based financial solution often discussed along with factoring. That is why invoice factoring vs invoice financing is a popular debate topic among manufacturers trying to determine which option suits them best. Even though both options are invoice-related, they cater to different business needs.
- In invoice financing, the factoring company does not take over the payment collection process. Instead, the business continues to collect payments from its clients. This process is also discrete; customers are unaware that the business is using a financial service.
- However, the invoice factoring process is not confidential since the factoring company becomes the business’s representative and gathers payments from customers directly.
Pros and cons of manufacturing invoice factoring
Businesses in the manufacturing industry can greatly benefit from using invoice factoring. Let’s take a closer look at its advantages and potential drawbacks.
| Pros of invoice factoring | Cons of invoice factoring |
|---|---|
|
Improves cash flow |
Expensive cost |
|
Cover expenses timely |
Impacts customer relationships |
|
No obligation on how to spend funds |
Potential debt in case of recourse factoring |
|
Outsource administrative tasks |
|
|
Prepare for future orders |
|
|
No debt incurred |
|
Advantages of invoice factoring for manufacturers
Factoring offers a range of benefits for manufacturers; these include:
1. Improves cash flow
The major objective of an invoice factoring service is to help businesses streamline their cash flow. Especially for manufacturing businesses, which generally deal with longer-than-average sales cycles, lengthy payment terms, a lower volume of clients and direct relationships with suppliers. With an immediate cash advance, manufacturers get access to liquid funds that can bridge the gap between the start of production and the time the invoice is paid.
2. Cover expenses timely
Manufacturing businesses face a wide range of expenses, including buying inventory, supplier payments, fixed operational costs, employee payroll, and more. Many of these expenses are monthly, but manufacturing projects take longer to complete and receive payment. During this time, the invoice factoring funds can be used to cover essential costs and continue to run usual business operations with no disruption.
3. No obligation on how to spend funds
Invoice factoring typically does not restrict businesses from spending the cash funds in a specific way. Manufacturers can spend the advance as per their needs. Some may use it to cover payroll, while others might pay their suppliers with the same funds.
4. Outsource administrative tasks
Transfer the administrative responsibility of collecting payments to your factoring company. They directly interact with your customers and regularly follow up to make sure payments are received on time. This allows you to save both time and money, and instead spend them on other important business tasks.
5. Prepare for future orders
When daily expenses are covered, payment collection is efficiently outsourced, and invoices are being paid on time, your business is better prepared to grab any new opportunity and take on more orders. Without invoice factoring, you would be too busy chasing client payments and negotiating with suppliers and potentially losing out on new deals.
6. No debt incurred
Invoice factoring is not the same as a traditional bank loan. Its evaluation criteria, process, and repayment structure are all different, and no interest rate is involved. That is why invoice factoring does not appear as debt on a manufacturer’s financial statements. Instead, it is simply the sale of future assets at a discount.
Disadvantages of invoice factoring for manufacturers
Like any other financial service, invoice factoring also has some drawbacks in addition to its benefits.
1. Expensive cost
The 1% – 5% factoring fee of the invoice value can quickly pile up, especially if you factor multiple invoices or incur the maximum fee. Over time, invoice factoring can become an expensive option compared to other financing options.
2. Affects customer relationships
The factoring company directly deals with your customers, so they are aware that you are working with a third-party financing service. Depending on the professionalism of the factoring company, the customer interactions might remain neutral or have a negative impact. Some customers may even interpret it as a sign that your business is financially unstable or less reliable.
3. Potential debt
In recourse factoring, the manufacturer is responsible for fulfilling the invoice if a customer fails to pay. This creates the possibility of debt to the factoring company in case of non-payment.
Tips to choose the right invoice factor for manufacturers
Now that we have discussed what invoice factoring is, along with its working, its advantages and disadvantages and costs, it’s time for manufacturers to search for a suitable factoring company. We have compiled a list of factors to consider before making your decision:
Recourse factoring or non-recourse
First, decide whether you want a recourse or non-recourse agreement. Both have varying levels of liability. Non-recourse factoring agreement transfers the liability of non-payment from the business to the factoring company. But it also comes at a higher cost due to the greater risk they take on.
Minimum number of factored invoices
Select and pick out the invoices that you plan to factor. If it’s just one, make sure your provider offers single invoice factoring. Some providers require businesses to factor a minimum number of invoices according to their policy.
Cost breakdown and affordability
Before finalising your contract, review the full cost breakdown. Look at their evaluation criteria for eligible invoices, what factor rates they charge, and whether there is a requirement for minimum contract length or sales revenue.
Professionalism and reviews
Your customers directly interact with the factoring company when you sign up for invoice factoring. That is why it is important that they are professional in their interactions to reflect your business’s reputation. Look for their real client reviews to get an idea about their working ethics and how they approach the payment collection process.
Customer service quality
You’ll want to work with a factor that provides reliable support for both you and your customers. Strong customer service is important for you to maintain your business relationships and stay up-to-date with the process.
Compare factoring companies
Before finalising any contract, compare quotes, contract terms and factoring fee from different factoring companies to get the best deals.
ComparedBusiness UK links you with top factoring companies in the UK
Want reliable invoice factoring for your manufacturing business in the UK? ComparedBusiness UK helps you with it by linking you with the top invoice factoring companies in the UK. Just submit your requirements in less than 2 minutes, and we will get back to you with suitable matches. You can choose the best option depending on your business needs.
FAQs
The process of invoice factoring starts when a manufacturer provides services or products to a business and issues an invoice. The factoring company then buys these invoices and advances 70% – 90% of their value. The remaining funds are released once the customers clear their invoices.
Invoice factoring helps manufacturers improve cash flow, cover expenses timely and operate without disruptions. It also allows businesses to outsource their administrative tasks of payment collection and get access to instant funds.
