If for whatever reason you need to get money for your business quickly, without hassle or risk, invoice factoring is likely your best bet. Invoice factoring is a financing method that allows companies to sell invoices to third-party factoring companies as soon as they are issued. It is a way for companies to receive immediate cash flow by selling their invoices at a discount.
Invoice factoring can help your business get the cash needed for short-term financing needs. It's great for businesses when you are researching a business loan, cash advance, SBA credit, or credit line, to name just a few examples. Entering into a partnership with a factoring company, allows you to access the funds owed to your company. Instead of letting your cash flow stop you from growing your business, you can start taking in larger customers by using factoring.
But what is a factoring company and how does it work? In essence, a factoring company purchases invoices from other businesses. Factoring companies are a common financing option for companies who are experiencing cash flow problems as a result of slow-paying customers.
Factoring companies do not focus on your company's financial history to determine the interest rate and terms of your financing. Factoring is a debt-free tool, it is a sale, not a loan and no interest is charged, so your company has no debt on its balance sheet.
You may also be wondering why a factoring company would take on your unpaid invoices. The transaction is profitable for the factoring company as they buy the invoices from your company at a discount rate, meaning that the amount you are paid is lower than the amount you are owed by your customers. This discounted rate is called a factoring fee and averages between one and five percent.
Factoring for invoices does not require collateral in the form of real estate or expensive equipment but business invoices can serve as collateral for the factoring company. It is important to note that factoring companies usually pay a lump sum of 70 to 90 percent of the invoice amount and calculate factoring fees, discount rates, and services as a percentage of the invoice amount.
Invoice factoring removes a lot of risk from your business. You can accept any of your customer’s terms, knowing you won’t actually need to wait for their payment. When using a factoring company, you will get your money now, instead of having to wait the usual 30, 60, or 90 days for your company to get paid. The invoices will be handled by the factoring company, from checking the clients’ credit, providing reports on every transaction to collecting all outstanding amounts.
For example, if your outstanding invoices totaling $10,000, a five percent factoring fee would amount to $500. This is the factoring fee and is the profit made by the factoring company. This means that you will receive $9,500, distributed as a cash advance (lump sum) and remaining advance. If the lump sum percentage is, for example, 70 percent, you will receive $6,650 right away and the remaining 30 percent once the factoring company has collected all payments for the factored invoices.
Invoice factoring is not necessarily a one-time deal. Depending on your needs, you can establish a continued relationship with your chosen factoring company. Without your credit history affecting the outcome, invoice factoring is a far better resource than taking out a loan with the added bonus of not leaving you in debt. It is your customer’s credit that is the qualification criteria. As long as they are in good standing, you are all set.
Unfortunately, there are some minor cons to invoice factoring as well. If the factoring fee is too high, if your business does not use invoicing to collect a payment, then this might not be the right option for you. An additional consideration is that another business will have information about your finances. Finally, you may need to buy back your factored invoices or sell additional ones, if the factoring company is unable to recoup its investment.
Regardless of the size of your business, it can, and, at some point, probably will be affected by cash flow problems. Many companies struggle to meet their everyday financial needs without a reliable source of cash flow. Smaller and growing companies need capital, but they have limited opportunities to obtain it. Invoice factoring is your way to get money quickly and remove financial uncertainty from your day-to-day operation.