For businesses that sells good or services to other, invoice factoring can be a way to keep working capital flowing more consistently. Invoice factoring involves selling invoices at a discounted rate to a factoring company. The factoring company then gives the business seller a lump sum of cash and collects the invoices personally from the customers. This arrangement comes with both positives and negatives that should be carefully considered.
- Quick Cash – Unlike traditional small business loans with banks or other lenders, working capital can be available immediately when selling invoices. That can make a huge difference to businesses that find frequent gaps in their funding due to slow payments from customers.
- Easier Credit Standards – Traditional small business loans and even some online lenders can require impeccable business credit records. Invoice factoring does not. They will look at the customers’ creditworthiness and the value of the invoice to determine the discount and fees.
- Retain Business Ownership – Some businesses turn to selling equity in their company in order raise the necessary funding, but that typically means giving up a measure of control. With invoice factoring, companies can receive the business funding they need without permanently losing part of their ownership.
- Saved Time – Instead of spending time tracking down customers and getting them to pay their bills, by selling of the invoices the factoring company will usually take over that responsibility. This frees up business owners to use their time more productively on growing their company.
- Costs and Fees – Invoice factoring is not the cheapest way of coming by business funding. Factoring companies will typically charge between one and four percent of each invoice as well as interest on the upfront cash advance, application fees and processing fees. There may also be fees if your clients do not pay their invoices on time. Businesses need to research all the associated costs and understand that the annual percentage rate might be much higher than expected based on the monthly fees.
- Long Contracts – While invoice factoring can be a short-term solution, ‘short-term’ can mean as long as three years. Be sure to negotiate the term contract down to fit your needs before signing on the dotted line.
- Relying on Customers’ Credit – Because factoring companies base their rates on the strength of the invoiced customers, a business may end up paying higher fees if their customers do not have robust credit histories.
- Perception – There may be some perception among clients that if a business has turned its invoices over to a factoring company, that the business is weak and desperate for cash. That idea might scare away some clients unless the business contacts it customers and explains its plan for using the factoring funding.
There are plenty of pros and cons associated with invoice factoring. Companies should do their due diligence before deciding whether or not it is a good source of business funding.