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Small business owners are always looking for new ways to improve cash flow and get ahead of the competition. Invoice factoring is a strategy that many business owners have successfully employed.
No matter what you call it, the idea behind selling invoices remains the same. You sell your invoices or accounts receivable to a factoring company for cash. In some cases, this puts the factoring company in the position of a bill collector. You have the cash in hand, and they are responsible for collecting the money and processing the payments associated with the invoices.
In the end, both sides win. When the factoring company assumes responsibility for the debt, the small business owner doesn’t have to worry about collecting. If the factoring company doesn’t assume responsibility for the debt, the small business owner still gets a cash advance to help them through a tough spot.
And of course, the factoring company realizes a financial gain as well. Here is an example we have shared in the past:
“Let’s say you have a $100,000 invoice with 30-day terms. A factoring company may immediately advance you 85% of that amount ($85,000), holding $15,000 in reserve. The customer then pays the invoice 2 weeks before the due date. After subtracting the 3% processing fee ($3,000), the factoring company would keep its factoring fee, which is 1% per week the invoice was outstanding (in this example that would be 2% or $2,000) and give you the remaining $10,000.”
There are a lot of numbers in that formula, but upon closer review you will realize it is actually quite simple. You don’t get the full amount of the invoice, as some of the money goes to the factoring company to cover fees. What you do get, however, is an immediate advance, as opposed to waiting around to be paid. For companies that need cash flow now, not later, this is just about as good as it gets.
Just the same as any business decision, you don’t want to decide in favor of accounts receivable factoring until you are 100 percent comfortable with the process and how it will unfold. To ensure that you are on the right track, here are four details you should always remember:
On the surface, before you complete detailed research, you may believe that invoice factoring and traditional loans can be easily compared. While both allow you to obtain money, there are some key differences between the two:
This does not mean invoice factoring is always the better of the two options. Factoring is generally option for those who can’t qualify for a traditional bank or SBA loan.
If you have outstanding invoices, there is a chance that factoring could be the answer you have been searching for.
However, factoring is only an option for some businesses. It is best if you:
While not the best choice for every company, any business that invoices in a B2B environment can qualify for invoice factoring. The only stipulation is that the company has outstanding invoices that can be sold.
Note: the amount you qualify for is based on the quality of your invoices, such as the terms, as well as the total amount and your credit worthiness.
Even though any company with a B2B business model can take advantage of invoice factoring, some of the industries that rely on this heavily include:
If your company operates within one of these industries, you may be in good position to benefit from invoice factoring.
Tip: when speaking with factoring companies, explain your business model and ask if they have experience dealing with businesses in your industry.
With so many other ways to increase cash flow and grow a business, it is hard for many small business owners to wrap their hands around the idea of invoice factoring. This is particularly true among those who don’t have any experience in this area.
Before you make your first move, compare the pros and cons of factoring against other methods of financing, such as lines of credit, short-term loans, and business credit cards.
The main reason companies turn to invoice factoring is to avoid lumpy cash flow. But, there are definitely other reasons a small business owner would turn to factoring. For example:
The reason why one company relies on invoice factoring may not be the same as the next. As long as you are comfortable with what it provides, it is something for your business to consider.
Before you decide in favor of invoice factoring, as opposed to other forms of financing, you should understand the many advantages. This will help you decide if this strategy is best for your business at the present time.
While every business will make its own list of factoring pros and cons, most soon realize there are four primary advantages:
After reviewing the many advantages of invoice factoring, you may be wondering what has taken you so long to consider this idea.
Despite the benefits, despite the fact that many companies have used factoring to their advantage, you still have to consider the good and bad before making a final decision.
Here are some of the primary disadvantages associated with invoice factoring:
Factoring is a fast, simple, and effective way to get the cash you need to grow your business.
Now that you understand the finer details, how this financing compares to other types, and the pros and cons, you are in position to decide if this could improve your company’s financial situation in the future.