9 Ways Invoice Factoring Can Help Your Business Grow
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Companies often need help managing their cash flow, especially in their growing stages. Most businesses don’t start with massive amounts of cash available, and maintaining what is available can be of the utmost importance. Specific financing methods can help keep cash flow steady. One commonly used type of financing is invoice factoring. This article will explore the benefits of invoice factoring to small businesses.
How Does Invoice Factoring Work?
Invoice factoring involves a company selling its open invoices to a business factoring company. In exchange for the right to collect payment from the original company’s customers, the factoring company gives the business an upfront amount that it can use for its working capital.
Usually, small business factoring services will provide the business with 60 to 80% of the invoice’s value. Upon complete collection of the outstanding invoice, the company will be provided with the remaining balance, less a fee for factoring help services. This essentially describes the process of how invoice factoring works.
What Is A Factoring Company?
A factoring company provides business receivable factoring to companies that need funding. You may find factoring services through your bank or obtain them from companies that offer accounts receivable management.
The services provided by a factoring company can be highly flexible or act as a complete extension of your accounts receivable department. The fees you pay to invoice funding companies will depend upon the level of services they provide.
How Do Factoring Companies Make Money?
If factoring companies provide small businesses with quicker access to their outstanding customer balances, how do they make money? Small business invoice factoring companies charge a fee for their services. Typically, this fee varies from 1 to 5% of the value of each invoice.
Invoice Factoring Requirements
If you’re considering invoice factoring for your business, you’ll need to meet specific requirements. While these vary from lender to lender, the following are usually considered before a factoring agreement can be made.
1. Clients Must Have Good Credit
A factoring company won’t likely agree to take on invoices for customers who don’t have good credit. Poor credit means more risk to factoring companies, which means they may lose money on the agreement. If you have many customers with poor credit, you’re better off working with a collections agency than a factoring company.
2. Company Must Have Good Profit Margins
For invoice factoring to make sense, you’ll need to have at least 10% profit margins in most cases. Otherwise, the money you spend on your factoring service will eat into your profits and may result in losses. If your company's goods or services don’t have a large profit margin, it is worth exploring whether increasing prices could be beneficial.
3. No Liens on Your Invoices
Invoices pledged as collateral to other sources won’t be accepted by factoring companies. Thus, if you have taken on a loan from a bank that has placed a lien on all of your company’s assets, you won’t be able to qualify for factoring. To get around this, you may request subordination from your lender. However, lenders don’t have to agree on subordinations if they don’t want to.
4. Meet Revenue Requirements
Some small business factoring companies require that you have a certain level of revenue before they agree to finance any invoices. Check with the factoring company to see if they have such limitations in place, especially if your company is just starting and hasn’t yet built solid revenue streams. In some cases, you’ll need to show thousands of dollars in revenue before a factoring company will consider your business.
9 Ways that Using Invoice Factoring Can Benefit Your Business
The benefits of invoice factoring can be pretty significant. Small businesses can unlock access to anticipated receivables and pad their cash flow when using invoice factoring. A few advantages of invoice factoring include:
1. Get Access to Funds Quickly
Once you’ve decided to factor your invoices, you’ll be able to receive financing quite quickly. Oftentimes, money is available within a week following the signing of a factoring agreement. If your company is in a severe cash crunch, invoice factoring can help resolve the issue and get you access to the money you need.
2. Not Reliant on Credit Score
Companies that are new or haven’t yet built their credit history can benefit from factoring help. You’ll be able to obtain the financing you need without providing a credit score. Since the lending is based on the credibility of your customers instead of you, factoring companies don’t need to consider your creditworthiness.
3. Easy to Obtain
As long as you meet the qualifications, you’ll be able to enter into a factoring agreement quickly. In some cases, you can start factoring within a business day or two. This is a sharp contrast with other types of financing, such as bank loans. Often, bank loans require several weeks — and lots of red tape — before you can obtain the funding you need for your company.
4. No Business Debt
Since factoring isn’t a loan, you’re not taking on debt that you’ll need to repay over time. The customers you have are responsible for paying their invoices, not you. You are simply benefiting from a quicker payout on their invoices. This means that your balance sheet will show limited liabilities (unless you’ve taken on a prior loan), which can benefit new companies. There’s also no personal guarantee required.
5. Relatively Affordable
While small business invoice factoring services charge a fee for their services, their costs may be less than what a new company with no credit history could obtain through debt financing. Someone with bad credit or a business with a limited lending history may have to accept significant interest charges before being accepted for funding. Choosing invoice factoring rather than debt financing can reduce finance expenses.
6. Money Can Be Used for Any Business Purpose
Traditional business loans often restrict how funding can be used. For example, an equipment financing loan is usually only available for equipment purchases, and a commercial loan may be constrained to purchasing company property. Business factoring for small businesses allows you to use the money for any purpose.
7. Limit Your Collections Efforts
Under an invoice factoring agreement, the factor becomes responsible for collecting unpaid bills, not you. This frees up you and your team to dedicate time to other essential activities, such as building sales or developing new products. You’ll no longer need to follow up with customers who are late with their payments or constantly review your aging receivables.
8. Build Your Company’s Credit
While invoice factoring doesn’t enhance your company’s credit directly, it does serve to help you with your working capital. You can make sure your vendors are paid on time by having the funding you need. In addition, most invoice funding companies don’t place limitations on companies seeking to obtain debt financing. This gives you the flexibility to get additional funding in the future if you need it.
9. Reduced Risk of Unpaid Invoices
It can be frustrating to sell a well-developed good or service to a customer, only to have them not pay you. When you choose to develop a relationship with an invoice factoring company, in most cases, they will be involved in the approval of new customers. Rigorous checks will be conducted to prevent bad apples from souring your revenue. This helps to eliminate the chances of bad customer debt.
Invoice Factoring Small Business Benefits
Now that you know the benefits of invoice factoring, you’re well equipped to decide whether this is a good option for obtaining non-traditional financing for your business!
Interested in invoice factoring to grow your business? Learn more about Fundid Capital to find out how you can get capital to grow faster.