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This guest article was written by Art Omega, an underwriter for BlueVine. Born and raised in the San Francisco Bay Area, he’s been in the factoring industry for more than 15 years, and is addicted to live escape room games.
If you’re new to invoice factoring, you’ll be excited to find out that it’s a small business loan option that can help fix your business’s cash-flow problems. And, actually, invoice factoring is something that many businesses—both big and small—take advantage of to get cash advances on yet-to-be-paid invoices.
With invoice factoring (also known as accounts receivable financing), businesses are able to get funds immediately instead of waiting 30, 40, or even 90 days when balances are due by effectively selling their invoices at a discount to a factor.
There are lots of great reasons why this could be an awesome idea for your business. The biggest, though, is cash flow—especially if you’re a seasonal business, your customers have varying payment schedules, or you issue only a few really big invoices all year and your cash gets tied up. Quick access to that capital could help prevent hiccups in your day-to-day operations, allowing you to grow faster than you’d be able to otherwise!
But as with any new financial arrangement, there are a few tricky details you’ll want to watch out for the first time. These are three of the most common invoice factoring mistakes. Know to look for these, and you’ll be putting your best foot forward:
You wouldn’t sign any other binding document without giving it a good, hard look, right? Then don’t make this invoice factoring mistake—read and understand your factoring agreement, too.
Your invoice factoring agreement is a legal document, and usually written in a formal legal language. And it might be difficult to wade through the legalese without contract experience. The most important thing, however? The terms in the factoring agreement should match the proposal you received.
But many times, you’ll see fee penalties or types of contingent fees for certain events not found on a proposal. This is where you need close attention—take a look at those fees, plus how they’re calculated. You might also find restrictions to the types of invoices you’re able to submit for funding within the factoring agreement.
With that in mind, know you can compare invoice factoring companies and their agreements so you can choose a company that’ll meet your needs with favorable terms.
→Too Long; Didn’t Read (TL;DR): Read that contract! It’ll not only outline the terms of your agreement but also any fees and contingencies. If you don’t, you could get stuck with a bigger bill than you anticipated.
Invoice factoring involves three relationships: the one between you and the factor; you and your customer; and also your customer and the factor, too. Those relationships need to be smooth sailing.
You’re the business owner, and that means you’ll need to help connect the factor—a.k.a. the company providing the financing—with your customer whose unpaid invoices you’re trying to turn into working capital.
Why? Well, since the factor gets paid by your customers, they’ll need to verify the quality of the receivables during onboarding. Plus, they’ll have to establish a contact that they can reach out to.
And you don’t want to micromanage that interaction! The factor might suspect something fishy going on, like funding fraudulent invoices.
You could also upset customers if they have to spend too much time dealing with the factor.
So, what should you do? The best solution is to reach out to your customers early on and tell them to expect a call from the factoring company. If you don’t already have it, ask your customer for the contact information for the person in charge of accounts payable. That’s who should be getting the heads up.
Then, reach out to your factor and share the contact information for the person you usually work with. They’ll then verify the business relationship and the accounts payable person who can verify invoices.
You can also share any pertinent details about your working relationship with that particular customer to help your factor be more efficient. If you have one, allowing the factor to access your vendor portal with the customer could help expedite the onboarding.
Making the process smooth for both your customer and the factor is an important step in building a good working relationship with all parties. And it can help ensure you’re set up for smooth sailing going forward.
→TL;DR: Good relationships are huge in making sure your invoice factoring process goes smoothly. Take care to establish good communication with your customer and the factor, and help them do the same.
Don’t make the big mistake of waiting until it’s too late to set up an accounting process that can accurately track your factoring details. You need to have procedures to track the factoring advances, fees, payments, and reserves. This could save you a lot of time later!
As a refresher, invoice factoring typically provides you with an advance of 80% to 90% of your invoice amount. Once your customer pays the invoice, the factor gives you the remainder of the invoice, also known as your reserve, minus the fees. (And remember, factoring fees might depend on how long the invoice remains unpaid!)
An efficient accounting system will also let you keep track of how much you’re paying in factoring fees and how your business is doing overall. Trying to go back and retrace a year’s worth of advances and fees on all the invoices you factored can be a nightmare.
So, don’t! Instead, set up a process from the beginning so you can keep a close eye on your business’s health and your factoring-related expenses.
→TL;DR: Make sure your accounting setup is prepared to handle factoring-related expenses, including fees, advances, payments, and reserves. Tracking them down at the end of the year is more than unpleasant.
Invoice factoring lets you unlock capital trapped in your unpaid invoices. This can help your business deal with short-term cash-flow gaps and can even help your business to flourish.
Many companies choose to factor but easily make one or more of these invoice factoring mistakes:
Avoiding these three mistakes can help you maximize the benefits of a smart financing option.