What is Invoice Factoring?
When you own your own business, you may find at times that you need extra cash. Whether you have a cash flow issue or want to expand your business and need additional funds to do so, there are a few options available to you. One of those is invoice factoring.
Invoice Factoring Explained
When a business needs additional cash or needs to lower its credit risk, it can rely on invoice factoring. This is a type of financial transaction that involves immediate cash being advanced to the business for any number of reasons. It works through the company selling its invoice or accounts receivable to a third-party at a discount cost.
This process is also often referred to as accounts receivable factoring. Generally speaking, it is a term that is appropriate for this type of lending, which is based on assets as it uses a business’ accounts receivable as collateral for quick funds.
How Does it Work?
When you choose invoice factoring, there are certain requirements that your company must meet. They include the following:
- You sell products or services to customers or clients and submit invoices for payment
- Your business sells unpaid invoices to a factoring company
- The factoring company checks the invoices and subsequently forwards your business funds of up to 90 percent of what is due on the invoice on that same day
- Your customers or clients make their payments directly to the factoring company as per the terms on their invoices. The factoring company returns the balance, minus a fee
How Does Factoring Differ from Getting a Traditional Bank Loan?
Factoring is different from taking out a traditional loan from a bank due to a business being required to sell its accounts receivable instead of having to put something up as collateral. In doing so, a company can immediately transform its receivables to cash. It overrides the need for the business to have to wait anywhere from 30 to 90 days or even longer for its customers or clients to pay their invoices and receive their funds.
Who is a Good Candidate for Factoring?
Overall, factoring can be a good option if your business needs fast funds but lack the ability to qualify for a traditional loan from the bank. However, if you do go this route, it’s important to thoroughly do your homework first to ensure that the factoring company you ultimately choose is reputable and legitimate. A good rule of thumb with these companies is that a truly good one will always research the credit history of the customers or clients of a business prior to agreeing to buy their invoices. The factoring company will also want to protect itself by ensuring that your company has a reliable history of paying its bills.
Additionally, factoring can help your business to gain additional funds while not incurring more debt. This is a great option for certain industries when they need fast, additional cash, including suppliers, staffing, importing, trucking and distribution.
5 Points to Consider When Choosing an Invoice Factoring Solution
You're almost ready to make your choice!
After careful research you are prepared to choose which invoice factoring solution you would like to pursue. Before you make your final decision, consider these five tips for choosing the solution that is best for you.
Honesty
The digital age has allowed scammers and criminals to hide their identities better than ever. When making the final step of choosing what solution is right for you, go with the option you feel you can trust the most. Talk with as many companies as you can to build a rapport with them. The ones that go out of their way to make you feel like your information is confidential are the companies that should make your final list.
Experience
Business is about taking risks. However, with your business the risk of a new factoring company might be too great. Look for companies with a few years of experience. Some companies may even allow you to talk to some of their clientele to see if they are happy with their service. Newer companies may struggle to figure out how to work in your particular industry and may create unwanted friction in the process.
What value is being added?
Aside from the standard services offered by factor companies, many offer bonus tasks or incentives for joining them. Make sure to ask any companies you're in communication with, whether they have any added value. Some example of added services that companies will include are customer service, invoice management, credit and background reporting, and online account reporting. Additionally, gauge their service offerings to you to how they would treat one of your own customers to see if the company is up to your standard of service.
Fees and Penalties
If you are simply looking for the lowest factoring fees, you may run into a problem. Many companies boast about their low factoring prices, but are actually adding on fees and penalties to every order.If you hear a company talking or listing the following fees in the fine print, it might be time to reconsider them as an option:
- Processing Fees
- Reserve Requirements
- Factoring Fees (Between 3-8%)
- The Advance Percentage
Being on the lookout for these fees and penalties will keep you weary of any company trying to pile on additional charges. If you see a type of fee or charge listed in their fine print, ask them about it. When talking to other companies, ask them about that fee, and whether or not they charge similar fees. Professionals will be quick to tell you what is standard.
Choosing your solution
Now that you have gone through this list of final thoughts, you are ready to decide on your invoice factoring solution. If you are being pitched, keep the above thoughts in the back of your mind to be sure you are making an informed decision.
