Business Invoice Factoring
Let’s suppose your company has unpaid invoices from customers. These are usually paid within 60 days. Invoice factoring is a way to get cash for unpaid invoices.
The invoices would be sold to a factoring firm, who would collect from the customer when due.
Cash flow for your business.
It is easier to approve than traditional funding options.
Comparable to other options, the cost of this option is much lower than others.
You have no control over the collection process.
Businesses that have unpaid invoices and need cash quickly.
Businesses that have reliable customers who are willing to pay on a long term basis (30, 60, or 90 days)
Invoice factoring is a way for small business owners to turn unpaid invoices into quick cash. This financing option is ideal for business owners whose customers include other businesses. Invoice factoring is a great option for businesses that don’t have the cash to pay their customers right away.
Here are some facts about invoice factoring.
What is Invoice Factoring?
Invoice factoring is technically not a loan. Invoice factoring is a way to sell your invoices at discount to a factoring firm in return for a lump sum cash. The factoring company takes over the invoices and pays you when it collects from customers. This is usually within 30 to 90 days.
Let’s suppose you own a hardware shop and sell goods to other businesses. You create a $10,000 invoice. The customer agrees that it will pay the invoice within 30 days. However, you still need cash to pay your employees next week. You’ve got a cash shortfall.
A traditional bank could offer a loan but you would need to have excellent credit and collateral. The lender might also require a tangible asset, such as real property, that they could sell in the event of default. You might be eligible but cannot wait for the loan to close for several months.
You contact an invoice factoring firm and they agree to purchase your invoice for $9700 in cash. This is $10,000 less a $300 factoring fee. In a matter of days, the invoice factoring company advances 85% (or $8245) of the invoice. The factoring company collects the invoice as soon as it is due and pays the balance ($1,455).
The discount rate or factoring fee (also known as the discount) can range from 1% to 5 percent depending on the amount of the invoice, the sales volume and creditworthiness of your customer. It also depends on whether the factor is non-recourse or recursive. Factor type is the name of who ultimately pays an unpaid invoice — either your company or the factoring agency.
If the contract is a recourse element and the customer fails to pay, you might have to purchase the receivable back from the factoring company. Or replace it with another receivable of equal value. You are not required to pay the customer back if the contract is a nonrecourse one. However, the factoring company will likely charge a higher transaction fee as it takes on additional risk that the money may not be returned.
Pros and Cons of Invoice Factoring
Invoice factoring pros
Fast cash: Invoice factoring is a quick way to get working capital that can be used immediately to cover funding gaps caused by slow-paying customers.
Cash flow improvement: Customers will be more loyal if they pay on a longer term. However, this can help to increase your cash flow and allow you to grow your business.
Easy approval: Invoice factoring allows companies to finance their operations without the need for collateral, poor credit, or limited operating history. Factoring companies are typically concerned only with the value of the invoices they’re looking at factoring and the creditworthiness your customers.
Invoice factoring does not require collateral. The lender may seize inventory or real estate if you default on your payments.
Invoice factoring cons
High price: This service is not cheap. Hidden fees such as processing fees for each invoice, application fees and late fees for clients who are past due for payments, credit check fees and late fees should be avoided. Late payments could result in an increase in your annual rate and the cost of borrowing money, including all fees and interest.
It is not for all businesses. Invoice factoring works best for businesses who work with other businesses, as transactions involve invoices. This option is not available to businesses that work with customers or sell directly to them.
Loss of direct control: The invoice factoring company could collect directly on your invoices. You need to ensure that it is ethical and fair when dealings with customers.
A factoring company might need to check the creditworthiness and credit score of customers. You may not be approved for financing if customers have a history involving late or missed payments or if the company has low revenue. As with other lenders, the factoring company will expect to be paid back.
No guarantee of collection: The invoice factoring company cannot guarantee that your unpaid invoices will be collected. Recourse factor: The factoring company might require you to purchase back the unpaid invoice, or replace it with one that is equal or greater in value.
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