Owning your own business can be rewarding, but those rewards require great risk and don’t come without a certain level of stress. One of the most common stressors faced by small business owners comes from stalls in cash flow due to account receivables delays.
When invoices are unpaid due to a slow paying customer, a dispute, or any other reason, the flow of cash feeding into your small business can slow to a trickle. In the meantime, the demands on your bank account for operating expenses like utilities, insurance, payroll and more don’t change pace to match your sluggish revenue patterns. If you don’t have a sufficient cash reserve to fill the void between your business bills and income, you may want to consider business invoice factoring as a means to generate working capital.
Your outstanding invoices represent potential income. Business invoice factoring companies are interested in buying these invoices in exchange for the opportunity to collect on your behalf (for a fee, of course).
This is where factoring your invoices and invoice financing differ. Accounts receivable factoring companies want to buy the invoice and take over collection. Invoice financing companies want to advance you a certain amount of cash, based on the value of receivables, but are not taking on the debt or responsibility for collecting the invoices. We dive deeper into the differences in the video below.
If every customer to whom you have extended credit paid their invoice on time, your cash flow might be fluid enough to support operations and expenses. That’s the premise, right?
But it’s not uncommon for small business owners to fall into an occasional bind. In those instances, you’ll need a cash reserve in order to maintain continual operations and cover everyday expenses. If you don’t have the luxury of a healthy business savings account or line of credit, invoice factoring may be your ideal option.
Of course, the convenience of business invoice factoring is not without its own cost. Invoice factoring companies recognize most small businesses in a cash flow bind are also short on time, therefore giving them the advantage to charge a premium for factoring your invoices. Typically the finance company will assess a processing fee for the privilege of the advance, and a second variable fee related to the speed in which the invoice is resolved.
These two fees can be a bitter pill for entrepreneurs to swallow. After all, you did the work for your client, and you’d like the full value of your invoices directed back into your business. But if you need a quick, reliable cash flow solution to maintain business operations in the short term, invoice factoring may be your best available option. This is especially true if you don’t have time to worry about collecting the invoice. By working out the details with a reputable invoice factoring company, you may also develop a relationship that will prove useful in the future, leading to more favorable terms following a mutually satisfactory transaction.
To help illustrate how business invoice factoring might work, let’s look at a real-world example:
Let’s say you have $100,000 on an outstanding invoice with 30 day terms. It’s quarterly tax time and the end of a payroll period, so you can’t afford to get behind on receivables, nor do you have time to worry about collecting it. To address your cash flow concerns, you approach the invoice factoring company about taking this invoice off your hands so you can get back to business.
To factor your invoices, the company would offer you an immediate $85,000 and hold $15,000 in reserve. From there, the company will work directly with your customer to collect the $100,000 from the customer. The factoring company could then apply a 3% administration processing fee ($3,000) along with a factoring fee to the monies in reserve. A common factoring fee is 1% for each week the invoice is outstanding—so, for example, if the customer pays their invoice within two weeks, your factoring fee would be two percent.
In this example, the factoring company will retain $5,000 of the $15,000 reserve. You’ll receive $10,000 once the account has been settled. Overall, you’ll see $95,000 of the original $100,000 amount receivable.
If you have a B2B business model with one or more outstanding invoices, you may be eligible for invoice factoring, regardless of your personal or business credit history. However, factors like your credit score and the quality of your invoices (value and age) will help determine both your factoring fees and the total amount of cash available to you.
As a business owner, you’re never eager to hand over your hard-earned revenue, so business invoice factoring is by no means an ideal set up. But if you’ve got bills to pay and your bank account is looking a little thin, it may be just what you need to keep your business operations in line.