Decoding Invoice Factoring: Common Questions From Small Businesses
by Fundid on Aug 18, 2023 8:00:00 AM
Running a successful small business can require having to focus on multiple components throughout the day, from accounting and sales to marketing and customer service. One financial process you may be unfamiliar with, but one that could benefit your business significantly, is invoice factoring. To help you get started on understanding this important tool for managing your cash flow, here we will include answers to some of the most common questions small-business owners have about invoice factoring.
What Exactly is Invoice Factoring, and How Does it Work?
Invoice factoring is a financing solution that helps small businesses bridge the gap between when they send out an invoice to a customer and when they get paid for it. Under this arrangement, a business sells its invoices at a discounted rate to a factor (the finance company) that pays upfront for them. They then collect the invoices in full from the customer and return the difference (less their fee) to the business.
This type of financing is beneficial for businesses with a high number of invoices or ones with long payment terms because they can receive funds upfront and don't have to wait 30-90 days (or more) for customers to pay them. This cash flow stability helps businesses to meet their financial obligations, cover operational costs and reinvest in their businesses.
Invoice factoring also offers additional benefits, such as increasing an invoice's credit limit so a business can take on larger orders that may be too risky otherwise. The finance company that is providing the funds takes on all of the risks associated with collecting payments from customers.
How can Invoice Factoring Benefit a Small Business?
As a small business owner, cash flow can be one of the most challenging aspects to manage. Invoice factoring can be a beneficial solution to help you maintain a steady cash flow. By selling your outstanding invoices to a factoring company, you can receive a quick advance on the funds owed to you and free up cash to cover your business expenses. This can help you avoid taking on debt or missing payments, allowing you to focus on growing your business.
Additionally, invoice factoring can help you save time and resources that would otherwise be spent on collecting payments from customers. With a reliable factoring company on your side, you can streamline your invoicing and payment processes and enjoy the peace of mind that comes with improved cash flow.
Related Reading: 9 Ways Invoice Factoring Can Support Your Small Business
What are the Costs Associated with Invoice Factoring, and How are They Calculated?
Typically, the cost of invoice factoring falls between 1% and 5%. The exact rate depends on several factors:
- Volume of Invoices: Businesses that factor larger amounts typically receive more favorable rates
- Average Value of Invoices: Higher value invoices may also attract better rates
- Customer Payment Practices: The reliability and creditworthiness of your customers can impact the cost of factoring
How Factoring Fees Are Calculated
Factoring fees are usually calculated based on the amount advanced against the invoice. For example, if the factoring company advances 80% of a $10,000 invoice at a rate of 3%, the fee would be $240 ($10,000 * 80% * 3%).
In some cases, the fee might be calculated on the face value of the invoice. Using the same figures as above, but calculating the fee on the full invoice value, the fee would be $300 ($10,000 * 3%).
Some factoring companies charge an annual rate, which is then applied on a weekly or monthly basis. Other fees may also apply, depending on the terms agreed upon with the factoring company.
As with any financial decision, it's essential to understand all the costs involved and how they're calculated before proceeding. Always read the fine print and ask questions if anything is unclear.
How Quickly Can a Business Typically Receive Funds Through Invoice Factoring?
Based on numerous sources, the timeline from application to funding can vary, but once set up, many businesses can receive funds within 24 hours of submitting an invoice. This quick turnaround can be particularly beneficial if your business is experiencing a cash flow crunch or needs immediate funding for growth or operational expenses.
Remember, before engaging in invoice factoring, it's important to understand all the costs involved and how they're calculated. You should also consider the reliability and creditworthiness of your customers, as this can impact the cost of factoring.
Invoice factoring can provide businesses with a fast, efficient way to improve their cash flow. As with any financial decision, it's essential to do your research and consult with a financial advisor.
Does Invoice Factoring Affect a Business' Credit Score?
The simple answer is no; invoice factoring does not impact your business credit score. This is because factoring is not a loan - it's the sale of your invoices to a factoring company. Therefore, it doesn't increase your company's debt levels, unlike other forms of finance.
Even if your business has bad credit, invoice factoring remains an option. Since factoring decisions are based more on the creditworthiness of your customers than your own business's credit, a poor credit score won't necessarily disqualify you from factoring.
Related Reading: The Complete Guide to Business Credit Scores
What is the Difference Between Invoice Factoring and Traditional Bank Loans?
When it comes to financing your small business, understanding the differences between invoice factoring and traditional bank loans can help you make informed decisions that best suit your cash flow needs.
1. Approval Process
One of the significant differences between these two financial tools is the approval process. Traditional bank loans often involve a lengthy and rigorous approval process, which may not be ideal if you need immediate funding. On the other hand, invoice factoring usually involves a much faster, streamlined approval process, with approvals often taking just a few days.
2. Collateral Requirements
Traditional bank loans often require collateral, such as property or equipment, which your business may risk losing if you can't repay the loan2. In contrast, invoice factoring does not require any collateral. The invoices themselves serve as the security.
3. Impact on Debt Levels
A bank loan increases your company's debt levels, which might affect your ability to secure additional financing in the future. However, invoice factoring is not a loan but a sale of your invoices, so it does not increase your business's debt levels.
4. Repayment Terms
Bank loans typically come with fixed repayment terms and interest rates. Failure to meet these terms could lead to penalties and negatively impact your credit score. With invoice factoring, there are no repayment terms per se, as the factoring company collects directly from your customers.
5. Interest vs. Factoring Fees
While bank loans involve paying interest over time, invoice factoring involves factoring fees, which are typically a percentage of the invoice value.
Are There any Potential Risks or Downsides to Invoice Factoring that a Business Owner Should be Aware of?
As a business owner, it's crucial to understand the potential risks or downsides associated with invoice factoring. This form of financing can provide immediate cash flow, but it is not without its drawbacks. Here are some key points to consider:
1. Loss of Control
Handing over your invoices to a factoring company means relinquishing control over a part of your customer interactions. For some businesses, this can be uncomfortable.
2. Negative Perception
There may be a stigma attached to invoice factoring, as it is not as well-known as other financing options. This could potentially impact relationships with customers.
3. High Costs
Depending on the level of risk and the factoring company's fees, invoice factoring can be expensive. It's essential to fully understand the costs involved before proceeding.
4. Dependence on Customer Credit
The cost and feasibility of invoice factoring depend significantly on your customers' creditworthiness. If your customers have poor payment records or bad credit, this could increase costs and complicate the factoring process.
5. No Guarantee of Collection
While invoice factoring can improve cash flow by providing immediate funds for unpaid invoices, there is no guarantee that the factoring company will be able to collect the invoice amount from your customers.
6. Not Suitable for All Business Types
Invoice factoring may not be suitable for all types of businesses. It's often best suited for B2B companies with high volumes of invoices.
How to Get Started With Invoice Factoring Through NowAccount
NowAccount's solution is not factoring, and it's not a loan. It's a simple platform that allows you to convert your receivables into cash quickly and easily. By uploading your invoices, you can increase your working capital, providing a much-needed boost to your cash flow.
The process is straightforward:
- Customer Approval - Add your customer and have them approved
- Upload Invoice - As soon as you receive an invoice, upload it into our system
- Receive Your Funds - Your ACH payment will be received upon approval
The platform is designed to be user-friendly, allowing you to track invoice progress and get paid within one day. All it takes is less than 5 minutes of your time, a business email and phone number, and your registered business name and legal form of business.
They charge an annual membership fee of $750. Now pays your business 100% of the invoice amount less the service fee of 3-7% of the invoice total. This fee is determined based on net terms, as shown below.
Net15 = 3% Service Fee
Net30 = 3.5% Service Fee
Net45 = 4% Service Fee
Net60 = 5% Service Fee
Net75 = 6% Service Fee
Net90 = 7% Service Fee
Annual Membership Fee= $750
NowAccount knows that your customers may not pay on the exact due date. This is a flat fee based on the invoice terms and will not change based on when your customer actually pays. Add a 1% surcharge for international invoices—special approval is needed for up to Net120 terms.