Do you have unpaid customer invoices but need financing to help run your business? Consider looking into invoice factoring. With invoice factoring you can turn those unpaid invoices into cash. This type of financing is popular among wholesalers, construction, manufacturing, and printing companies. Here is what you need to know about invoice factoring and how it can help your small business.
What Is Invoice Factoring?
Invoice factoring is not a loan, but it does help you get the cash that you need for your business. You can sell all your unpaid invoices at a discount to a third-party factoring company in exchange for cash. The company will then give you 85% to 95% of the invoice total upfront and hold a percentage of the invoice value until the customer has paid the invoice. Once they pay, you will get the reserved money without a factoring fee.
If your customer fails to pay the invoice, it will fall under recourse factoring or non-recourse factoring. Non-recourse factoring involves the factoring company assuming the total risk for the invoice. If the customer does not pay, you will not be held responsible. With recourse financing, your company will be liable for unpaid invoices. Most factoring agreements follow the recourse factoring model.
Invoice Factoring vs. Invoice Financing
The terms invoice factoring and invoice financing may be used interchangeably but they are not the same. Invoice financing gives you the ability to borrow against outstanding accounts. When the customer pays you, you will repay the lender upon value and fees or interest. On average, processing fees for invoice financing are lower than invoice factoring. On average it is 1%-3% a month rather than 2%-5%.
Is Invoice Factoring Right for You?
Invoice factoring is not best for all businesses so there are some important questions you need to ask yourself to see if it is the right fit for your business.
- Are my finances suffering because of slow-paying customers? – having slow paying customers can affect your ability to manage your business expense, paying employees, or covering costs. If this is your case, invoice factoring can help you get the working capital you need for your business.
- Can I afford invoice factoring? – invoice factoring is not cheap, there are fees that you may be charged such as monthly minimums, renewal fees, service fees, and money transfer fees. You will need to look at your options and decide if you can afford invoice factoring and if it is worth the cost or not.
- What is the age of the invoice? – newer invoices are more valuable because there is a higher chance it will be paid. It will be easier for you to sell to an invoice factoring company if it is less than 30 days old.
- Is another financing solution better for me? – there are many other options to consider besides invoice factoring such as lines of credit, business credit cards, and short-term loans.
Advantages and Disadvantages of Invoice Factoring
- Same day funding
- Easy approval
- Borrow only against the invoices you want to factor
- The invoice financing company assumes responsibility for collecting the invoice
- Financing can be renewed quickly and easily
- No credit requirements
- No collateral necessary
- High cost due to hidden fees, processing fees, application fees and more
- Loss of direct control
- No guarantee of collection
- You get 80%-90% of the face value of your invoices upfront
The Bottom Line
Invoice factoring is an attractive choice for many small business owners because the third-party factoring company takes responsibility of the collections which gives you more time to run your business. Although it is not cheap, it is great if you need access to cash quickly to pay for payroll or materials. If you find that invoice factoring is not right for you, there are other options available like cash flow loans and small business loans.