When you own a business, you may have more invoices due than money coming in right now. Fortunately, there are financing methods to help you out, such as invoice factoring.
But what is invoice factoring, exactly? Read on to learn more about this alternative financing method!
What Is Invoice Factoring?
Also known as factoring or debt factoring, this is a financial product that allows businesses to sell unpaid invoices to third-party factoring companies.
The factoring company would purchase the invoices for a certain percentage of the total value, taking responsibility for collecting them.
This type of financing is growing in popularity, as it is becoming more challenging for companies to use traditional finance products from various financial institutions, especially if they have imperfect credit scores.
How Does It Work?
When invoice payments have been purchased, the factoring company would pay in two instalments. The first one would cover the bulk of receivables, fulfilling the need for the quick cash-flow. The remainder will be sent once the client settles the invoice payment, minus the factoring fee.
These are the basic steps of using invoice factoring:
- Submit details of the invoice payments to the company to see if you’re eligible. The company will assess the risk of loaning, then giving you the fees and quotation.
- Once you have agreed on a rate and fee, the company will advance the funds for you to use. Then, the collection will begin with your clients.
- After the invoice payments have been collected you will be paid the remaining balance of the money owed, with the fees subtracted.
Why Choose Invoice Factoring
You’re probably wondering: Why use invoice factoring? Isn’t it more cost-effective to wait for the client to pay?
Unfortunately, some clients don’t pay on time, or it will take at least 30 days to collect payments. Businesses will require access to funds and cash flow instantly, and to speed up the lengthy process, they opt to sell the invoice payments for a certain fee instead.
This prevents huge cash flow issues, which can lead to bank overdrafts or business loans. At least with invoice factoring, it can add value to your cash flow immediately.
Furthermore, this is a good choice for businesses with an imperfect credit score.
How Much Does It Cost and Can It Save Me Money?
The exact invoice factoring fees would vary, depending on the company you work with. There are several factors to consider when thinking about the fee:
- A few companies may charge application and/or due diligence fees, while others do not. This can cost from $0 to a few thousand dollars!
- There are closing fees, with companies retaining a small percentage per invoice. However, some companies do not charge this.
- Companies might require you to sell certain amounts of your invoice monthly, signing a long-term contract. If ever you don’t meet the monthly target, there will be a minimum monthly invoice fee. There is also a cancellation fee when terminating the contract, which is usually the percentage of your credit.
- The fees associated with paying invoices in advance can be between 1-5% of your invoice value every month.
- If the invoices go over the 45 days covered by any advanced discount fee, then there may be additional charges of up to 3% every 30 days of the outstanding balance.
Because of these high fees, can this method actually save your money?
Think of it this way: With invoice factoring, you can convert your invoices into cash right away, rather than waiting for an entire month or so. This permits you to pay your bills and grow your business further, paying your vendors on time to get discount offers.
In the end, this can save your money, which makes good business. Just make sure you choose a reputable company with reasonable rates!
The Pros and Cons of Invoice Factoring
Here are the advantages of invoice factoring:
- You have a quick and safe sour of cash flow to pay off expenses
- Less time and effort spent on chasing late payments and admin work
- It can help expand and contract with the sales ledgers
- The financing method is less expensive compared to going to equity investors
- Invoice factoring companies are trained to send in professional reminders to improve the payment times of clients and customers for the long-term
- Invoice factoring gives your business better cash flow in case of different credit terms with your clients
However, there are a few disadvantages to take note of, such as:
- It may affect customer relationships when letting your customers know there is a third-party collecting invoice
- The costs are more expensive than bank loans
- It may reduce your scope for more borrowing
- There is a sense of losing control as you hand over the responsibility of your accounts receivable to a third-party
Weigh these pros and cons before considering invoice factoring. If you feel like this method suits your business, start searching for a trusted company to work with you for your needs now.