Trading with overseas buyers tends to carry more risk than trading domestically but it also offers opportunities for huge growth. One of the riskiest elements of exporting is usually around getting paid and therefore it is very important that sellers consider how they can reduce this risk.
There are a number of ways you can de-risk getting paid, and each has their own advantages and disadvantages. These include payment in advance, letters of credit, and trade credit insurance. In this article, we take a look at invoice factoring and confidential invoice discounting.
Invoice factoring involves a third party, a factoring company, buying your invoices at a lower than face value price, and then recovering the full value of the invoice from your customer. Essentially, they are buying the debt from you and it is they who take the risk of not getting paid.
The biggest advantage to factoring your invoice is that you definitely get paid and in a timely manner. This removes the risk of not getting paid and doesn’t compromise your cash flow.
The most obvious disadvantage of factoring is that you lose a proportion of the value of your invoice. This will need to be accounted for when setting your sale price. Most factoring companies will also expect to take your whole sales ledger rather than allowing you to simply select your most risky contracts. This means that you will have to pay fees even for very low risk invoices. This allows the factoring company to spread their own risk.
Because the factoring company deals directly with your customer to recover payment, you also have to trust that they will deal with your customers in the same professional way that you would, otherwise you could potentially risk damaging your trading relationship by association. There is even potentially a reputational risk as some buyers may associate factoring with companies who are struggling financially although nowadays this is part of the set up discussion with the factoring company.
Confidential invoice discounting is similar to factoring, with the main difference being that your buyer remains unaware that a third party is involved as you will always deal with them to secure payment. Confidential invoice discounting is facilitated by an invoice finance provider. You invoice your customer and send a copy of the invoice to the invoice finance provider. They then pay an agreed percentage of the invoice, usually within a couple of days. When the customer pays their invoice, you receive this minus a fee.
As with factoring, the main benefit is that you receive a payment very quickly. You also retain the relationship with the customer, so you have control of the whole process. The customer remains unaware that a third party is involved so there is no negative association.
Confidential invoice discounting is usually less expensive than factoring.
As with factoring, you lose a percentage of each invoice and most invoice finance providers will want your full book. With this method there is still an element of risk if the customer does not pay as you wouldn’t receive the final balance.
If you find that you wish to end either of these types of agreements with your providers, you are free to do that (depending on your agreement). However, any monies that have been paid to you for invoices that have not yet been paid by the customer would have to be given back to the provider and this needs to be carefully planned so as to not impact your cash flow.
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