The manufacturing industry relies heavily on its suppliers to keep the work flowing. Post-production, the customers receive deliverables as per the invoice. Now ideally, customers should pay upfront to the manufacturer. However, owing to the high costs, manufacturers offer payment terms to the customers. Usually, manufacturers can’t afford to provide the payment terms due to the limited capital. A convenient solution is to cash on active invoices via manufacturing factoring. It allows manufacturers to keep receiving the raw materials and offer flexible payment terms to the customers.
What Is Manufacturing Factoring?
Manufacturing is a capital-dependent business. The costs range from equipment lease and maintenance to raw material and staffing. It is challenging to adhere to liquidity while offering payment terms to the customers. Asking customers to make early payments isn’t a viable solution. Hence, manufacturers need to look for alternatives to make things work. A bank loan isn’t feasible either, as it takes a long time to receive the cash. Also, additional interest adds on the burden on manufacturers instead of relieving the financial strain.
As an alternative, manufacturing companies’ tie-up with factoring companies. A factoring company evaluates the active invoices of the manufacturer from creditworthy customers. On successful evaluation, manufacturers can cash up to 95% of the invoice. This process is called manufacturing factoring. In turn, factoring companies receive the payment from customers to compensate for the cash.
A swift transaction within a short period is crucial to manufacturers to meet delivery deadlines while keeping up with customer satisfaction.
Types of factoring
Two types of factoring are prevalent in the manufacturing industry- Full Recourse and Non-Recourse factoring.
Full Recourse Factoring
Every business is subject to bad debt, and manufacturing is no exception. When a factor cashes the invoice, there is a high risk of it turning into bad debt. Hence, the manufacturer and factor construct a deal wherein the manufacturer needs to buy back the unpaid bills. This tradeoff takes off the risk from the factor and is upon the manufacturer. When deciding the factoring rate, the risk plays a significant role.
Non-recourse factoring allows the factor to bear the risk of unpaid dues from a customer. The agreement between the factor and manufacturer is struck to include the cost of the risk. Often, non-recourse factoring works as credit insurance.
Benefits of factoring
Manufacturing factoring has proven to aid the essential cash flow to keep the industry finances rolling. The additional benefits of factoring are-
- The flexibility of payment to suppliers
- Expansion of business in terms of staffing and new deals
- The faster turnaround time to cash invoices
- No long-term contracts laying from 6months to a year
- Easy elimination of debt
A sustainable cash flow is imperative to manufacturing to keep up with the incurring costs. While bank loans take longer to provide financial assistance, factoring comes in as a favorable recourse. It helps the manufacturer in relieving the financial constraint with affordable choices.