Invoice factoring and debt collection are two disparate things that frequently get mistaken for one another. Though the two really have nothing to do with each other, misunderstandings abound. As such, it is a good idea to review the roles of factoring companies and debt collection agencies, how they are different, and the common reasons for confusion.
What Is the Role of a Factoring Company?
Companies that provide invoice factoring (aka factoring receivables) services differ from debt collections agencies in numerous ways. First and foremost, the primary function of an accounts receivable financing company is to provide fast, same-week financing solutions to improve a business’s working capital or cash flow. It does this by expediting invoice payment from current clients.
Specifically, a factoring company runs a credit check on the business’s client to ensure it is creditworthy. Once this has been confirmed, the factoring company pays the business the amount of the invoice (minus a percentage) so that the business receives invoice payment right away.
The factor then collects the actual invoice payment from the client during the standard payment timeframe (usually 30-days). As a courtesy to the business, oftentimes the accounts receivable financing company will “collect” and process the incoming invoice payment. For this reason, invoice factoring companies are sometimes confused with collection agencies.
An Important Clarification on the Term “Collection”
Though factoring companies “collect” invoices from clients on behalf of the business, they are not in the business of debt collection. It is true that an invoice itself signifies an amount a client owes a business and that an accounts receivable financing company facilitates the collection of that invoice. However, this is not the same as debt collection.
What Is the Role of a Debt Collection Agency?
Debt collection is a formal process or procedure that involves collecting on debts that are past due. So right here is a big difference between factoring receivables and collections. Factoring companies are collecting on current invoices, debt collectors are collecting on past due invoices.
Collecting on Invoice Payment Is NOT the Same as Debt Collection Proceedings
So if a client owes money to a business but fails to pay what it owes within a certain time period (usually 90 days), the two entities then enter a formal debt collection situation. Of course, this debt collection phase is only entered after all options to collect payment have been exhausted. These standard options include the business calling or sending written correspondence to the client inquiring about money it is owed. These attempts to collect on unpaid invoices will occur several times over before a situation reaches the point where true debt collection is involved.
So What Is Debt Collection Then?
True debt collection occurs in a situation where the debt is considered uncollectable. This means the client hasn’t paid their invoice despite numerous attempts on the part of the business to collect invoice payment. The debt will be written off as a business loss should debt collection efforts fail.
Truth be told, formal debt collection procedures are not pretty. In such situations, the business that is owed money will hire a debt collection agency (this is often a law firm) to go out and aggressively collect the debt they are owed. Needless to say, the relationship between debt collectors and debtors is not entered into voluntarily.
Though the law limits the actions a debt collection firm can take, debt collectors are permitted to seize assets, equipment, machinery, vehicles, and more to repay a debt. They can even garnish wages in extreme situations.
Debt collection is a last resort option. Rather than write of the debt as a loss, the business hires a debt collector to aggressively go after the client to collect money owed to them. As you can see, this is nothing like what an invoice factoring company does.
Accounts Receivable Financing Companies Process Receivables
By comparison, an accounts receivable financing company simply facilitates the collection of payment so that the business receives invoice payment faster than it would otherwise. It does this by serving as the middle man and shoring up this capital to the business as an advance and then collecting standard invoice payment later. By later, we mean within the usual 30-day payment period (thereabouts). Debt collection is not warranted for remitting payment within 30-days.
Factoring Companies Handle Back-Office Accounts Receivables’ Tasks
The factoring company does, however, perform back-office accounts receivables duties. This involves managing the invoice payment process, noting when payment was received, and balancing the books accordingly. If receiving invoices makes a factoring company the same as a collection agency, then essentially every business would be a collection agency.
Again, collecting invoice payments is not the same as debt collection; it is merely an accounts receivables’ function. Invoice factoring companies perform this receivables handling service to its customers as part of the larger accounts receivable financing process.
Along these lines, invoice factoring companies will perform the collections functions in reminding the client when payment is due or calling upon a client to remit payment. This is done as a courtesy, to speed along the invoice payment process.