Invoice Factoring: The Pros and Cons for Business Owners
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Business owners sometimes struggle with collecting all the money due to them by their clients in a timely fashion. Waiting on receipts can cause problems with company cash flow, especially in cases where there isn’t a large cash cushion. Fortunately, various options are available to improve collections.
What Is Factoring?
Small business invoice factoring is a receivable management method that allows companies to sell their unpaid invoices to a third-party company in exchange for cash. The third-party provides the company with a percentage of the invoices’ value upfront, which may range from 60 to 80%. They will then handle collection activities with your customer.
Once the customer has fully paid their invoice, the third party will subtract a service fee from the value of the invoice that was not included in the upfront payment, then return the rest of the invoice’s value to the company.
Invoice Factoring Advantages and Disadvantages
As with any type of financing, there are pros and cons to consider when reviewing your options. Here are a few advantages and disadvantages of invoice factoring.
Pros of Factoring
The benefits of invoice financing include:
Create a Stable Cash Flow
Invoice factoring can provide a ready solution for companies that struggle to maintain a balanced cash flow. Using factoring allows companies to gain access to the cash that they need. Businesses can use this money to meet regular expenses, such as payroll, vendor payments, and rent. Factoring can give business owners better peace of mind and control over their finances.
By factoring, a business can help to improve its credibility for increased financing opportunities. Once a factoring company agrees to buy invoices, and the business’s clients pay the invoices on time, the business can build a relationship with the factoring company. This can lead to more opportunities for other types of financing, which can further increase working capital and potential for growth.
Financing Without Debt
Is factoring debt? Invoice factoring isn’t a type of debt, as you’re selling a business asset to another company. You're not adding debt to your balance sheet when you sell the right to collect on those invoices. Invoice factoring isn’t a loan. However, some companies refer to invoice factoring as “debt factoring.” The advantages of debt factoring, and its cons, are the same as those described in this article.
Good Opportunity for Startups
A startup won’t have the business or credit history needed to obtain a loan from a traditional bank. Thus, their primary source of funding will have to come from sales. Invoice factoring can be an excellent option for a startup that needs the money for working capital to ensure stable cash flow. Other types of invoicing often require a longer time in business, so this is one of the top benefits of factoring for new and growing companies.
There are numerous invoice factoring companies available that work with all types of companies. Thus, working with an invoice factoring company can be easy to do. You’ll need to research to find one that aligns with your objectives and ensure that its terms are reasonable.
Gain Collections Help from an Experienced Team
While obtaining upfront funding for your company is the main goal when working with an invoice factoring company, another benefit you’ll gain is a collections team that will work on your behalf. The invoice factoring company will want to ensure they receive full payment from all purchased invoices. However, they will do so in a way that doesn’t damage your client relationships and should be coordinated with you as the business owner.
Cons of Factoring
As with any business financing decision, factoring has certain drawbacks.
Can Be Expensive
Factoring is one of the most expensive types of financing. You’ll typically pay between 1 and 5% of the total value on all invoices that you factor in. These costs are higher than you might pay in interest for a bank loan. However, it is possible to build the cost of factoring into your revenue and pass it to your customers.
Not for Every Business Type
Some businesses, such as retail outlets, restaurants, and hospitality companies, don’t invoice their customers. Instead, the customer pays upfront for their services. These types of companies won’t be eligible for invoice factoring due to how they collect payment.
Problems with Non-Payment
If a customer doesn’t pay their invoice and a factoring company purchased it, then the business owner may be required to settle the amount with the invoice factoring company. For companies with limited cash flow, this can be hard to do. Ensure that you understand the terms your invoice factoring company has put in place. Some factoring companies will assume the loss on an unpaid invoice, while others will ask for repayment.
Loss of Control
Once you sell your invoices to a factoring company, they retain the rights to collect from your customers. It’s a good idea to let your customers know that the factoring company will be handling the collections for you.
Sometimes, a factoring company may pursue collections differently than you would. Make sure that you understand your factoring company’s collection procedures so that they don’t cause problems with your customer relationships in the future.
What Makes a Business Suitable for Factoring?
Invoice factoring is best for companies that sell products or services to other businesses. In most cases, sales are of a higher value than they would be to traditional consumers, and there are actual invoices involved.
When invoicing business customers, payment is usually required within 30 to 90 days. These are the types of invoices that are most attractive to invoice factoring companies. Before beginning, ensure you have a solid understanding of the advantages and disadvantages of invoice factoring.
How Can I Get Invoice Factoring for My Business?
To obtain invoice factoring, you’ll need to shop around for a company that will work with you. Most factoring companies will only accept clients who have invoices payable within 90 days.
You’ll also want to consider the creditworthiness of your customers. You don’t want to sell invoices for clients who don’t have a solid history of paying on time. Factoring invoices for customers like this can sometimes lead to you having to come up with the money to repay your factoring company if the customer refuses to pay their invoice. It can also sour your relationship with your invoice factoring company.
When looking for an invoice factoring company, pay close attention to the terms and conditions of their agreement. If the terms don’t align with what you are looking for, they may not be the right choice for you. Do a thorough search on the internet for reviews of the company. Bad reviews or issues with the Better Business Bureau (BBB) should raise a red flag.
Some banks offer invoice factoring services for their customers. You can check with your bank to see if they provide invoice factoring. There are also online vendors, like Fundid Capital, who offer invoice factoring services.
Growing Your Business with the Right Financial Strategies
Selling receivables to a factor can be an excellent way to stabilize your company’s cash flow, allowing it to continue operations and meet essential payments. It’s a perfect choice for companies beginning to scale their growth and need funding without taking on debt. Before doing so, consider the accounts receivable factoring advantages and disadvantages discussed in this article.
Interested in invoice factoring to grow your business? Learn more about Fundid Capital to find out how you can get capital to grow faster.