Invoice Factoring for Contractors Explained

Tracing its roots all the way back to ancient Mesopotamia, invoice factoring is backed-up by a history as old as that of banks, or even merchandising in general. It has evolved through time by virtue of trade and has since remained to be a popular option for small to medium-scale businesses in need of some ready cash-at-hand. Today, invoice factoring for contractors is often viewed as a quick fix for sudden shortage in capital. But first, how does factoring work?

What Follows the Purchase Order?

Everything starts with an agreement between a supplier, often called a "contractor," and a client. Whether the contractor provides supplies or specific services, the way modern financing works has eliminated the need for a quick exchange in cash. For bigger projects, clients could opt for a longer period of payment, which usually varies and ranges from 30 up to 90 days. A purchase order is usually followed by an invoice, a piece of legally binding document which serves as a promise of the client that payment would be given to the contractor on a specified date, which is normally not that soon, at least from the supplier's perspective. This is where invoice factoring comes in.

The Third Party

Invoice factoring for contractors occurs when the supplier decides to utilize the invoices issued to them, the accounts receivables that they have on hand, to advance a portion of the payment that is not due until some specified time in the future. This is where the third party financing company enters the picture. Banking on the credit worthiness of the client's customer (the one which issued the invoice) instead of the client (the one "selling" the invoice) itself, the factoring company then takes over the responsibility of waiting for the full amount to be recovered in due time. In the meantime, around 75% - 80% of the total amount is advanced to the client, while the remainder is given back once the payment has been settled. The factoring company does get a small percentage which they bill the client as part of their services, which is exactly how they earn their profit.

Ready Capital

Once the invoice has been "bought" by the factoring company, it simply means that the burden of waiting is no longer a concern of the contractor. Now that most of the amount has been liquidated, this new inflow of capital could be used for whatever urgent financing dilemma the company is facing. A bank loan is usually hard to secure given the collateral required, as well as the stringent guidelines setup by banks. This is why invoice factoring for contractors is a viable option because it makes the whole process way easier for such small or medium-scale enterprises. In effect, they get to enjoy almost the same benefits they would from getting a loan, but with less hassles and a quicker turnaround time. For important money matters that need fast solutions, this is truly an option worth considering.