Invoice Discounting: Understanding the Requirements

Factoring arrangements can offer many financial benefits for a business facing temporary cash flow or working capital problems. There are many advantages to this line of financing, including the speed of processing, ease of qualification, availability to young businesses and flexibility of terms among others. This article discusses the main requirements a business must fulfill to be eligible for factoring.

  1. You should own or operate a business

Factoring companies can only offer financing for existing and operational businesses. There are factors that provide services to partnerships and even sole proprietorships, but most providers prefer businesses that have some kind of corporate structure such as limited liability companies (LLC) or Corporations (Inc.).

  1. You should have B2B clients

Factors work by offering you a chance to sell off your accounts receivable to them. These companies will only buy invoices from commercial companies or government departments. It is rare for them to buy invoices from individual/retail customers.

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  1. Your clients should have good credit/repayment history

The best thing about using invoice discounting is that you’re offered funds on the basis of your invoices/client’s credit rather than the credit of your own business. Factors will only take up high-quality invoices, which are invoices that are likely to be paid up as soon as they are due. They will look into the credit history of your clients to assess quality of your invoices.

  1. You should have profit margins of at least 10-15 percent

Factoring is a little more expensive than regular lines of credit, therefore it will work best if you have a reasonably high profit margin – at least 10-15 percent over the cost in order to leave you with some profit after the transaction fees have been deducted. The smaller the company or smaller the invoice amounts, the higher the profit margins should be.

  1. Invoices must not have any encumbrances or liens

Invoice discounting can only be used for invoices which have not been used as collateral for other lines of credits, such as bank loans. Bear in mind that many financing institutions file ‘all asset lines’ when providing funds, and such liens usually include your accounts receivable.

If you want to use your invoices for factoring, the other credit provider should agree to subordinate the invoices before the factoring company can take it up. Legal judgements or tax liens are also a form of encumbrance on accounts receivables and they have to be resolved before factoring can work for you.

  1. Create a payment plan for any tax problems or liens

Factoring companies can buy invoices which are tied by a tax lien if certain conditions are met, which are:

  • You should have a payment plan for the lien
  • The taxing authority should agree to subordinate its position regarding those accounts receivable

If your company is able to, you can simply pay the lien which clears the obligation.

  1. You shouldn’t have bankruptcy proceedings

Finally, you can have factoring carried out for your invoices while going through a Chapter 11 bankruptcy, but this is a complex and often more costly process. Nonetheless, factoring can work for certain debtor-in-possession funding when the circumstance is right. Most factors will however avoid companies that have open bankruptcy proceedings, whether personal or corporate.

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