Invoice factoring has been growing in popularity among growing businesses as a reliable and efficient method of raising financing.
Factoring alleviates business owners from the pressure and stress of paying their bills or staff salaries on time, allowing them to plan for sustainable growth well in advance.
Business success is usually determined by how well-managed a business’s cash reserves are. For a lot of small and young firms, it can be an incredibly frustrating time waiting for their clients to pay their outstanding invoices. This makes maintaining a positive cash flow to be quite a challenge, especially for businesses that provide payment terms to their clients.
With very few viable financing options available, invoice factoring has emerged as a less-risky solution not just for the business, but also for the lender.
In this article, we’ll take an in-depth look into what invoice factoring is and how companies can benefit from leveraging factoring as an alternative method of business financing.
What Is Invoice Factoring
Invoice factoring is a way of monetizing a company’s outstanding invoices by selling them to a factoring company. In exchange, the factor provides the business with a cash advance of around 80% to 95% of the invoice value.
After this transaction, the factor is the holder of the invoices and is required to collect payment on the invoice. This means that the factor assumes full credit control and can deal with the customers directly.
Although this alleviates businesses from the hassle of chasing late-paying clients, it could create an undesirable customer perception for your business if the factor takes drastic measures with the debt collection.
After the invoiced clients make full payments, the factor pays any remaining amount to the business after deducting their factoring fee. As is with any financial transaction, charges are involved. A factor will charge a factoring fee between 1% and 5% for the service.
Bear in mind that you should not confuse invoice factoring and invoice discounting. While the two are both a means of acquiring a cash advance on unpaid invoices, there are several aspects that set them apart.
For starters, invoice discounting provides businesses with secured loans against outstanding invoices while invoice factoring involves factoring companies outrightly buying the unpaid invoices.
Secondly, with invoice discounting, the advance must always be repaid since it is more of a loan rather than a sale. Invoice factoring, however, may be non-recourse. This means that if a business sells an unpaid invoice and the customer fails to pay, the factor is liable for the loss, and not the business.
Let’s look at some of the benefits businesses can expect from invoice factoring.
Benefits of Invoice Factoring
1. Quick and Easy Access to Working Capital
Growing enterprises need positive cash flow if they’re going to fund business operations such as paying employees, suppliers, and overhead costs such as rent and utilities.
However, if a business offers credit facilities to its customers, meeting these costs can be quite challenging. This is especially true for businesses that offer relatively long credit periods. But with invoice factoring, businesses can get the financing they need in as little as 1 to 3 business days.
Traditional financing options such as bank loans could take weeks or months. For startups and small businesses, this could be time they may not have on their side.
And since they have little credit, they might find they haven’t qualified for the loan after waiting for that long. This brings us to our next point.
2. High Chances of Approval
Invoice factoring is easier to get than most financing solutions. The criteria that determine a business’s chances of receiving funding are very few.
Unlike traditional financing solutions that require a company’s credit score, considerable financing history, and collateral, factors only require an unpaid invoice.
There’s no collateral required and as far as credit scores are concerned, the factoring company is concerned with the creditworthiness of the customer required to pay the invoice and not the company in need of factoring. So if you have low credit or have unpaid loans that have dented your creditworthiness, invoice factoring might be a viable solution for you.
It’s worth pointing out that it helps a lot if a business establishes a long-standing working relationship with a factor. The business can negotiate more flexible rates and cash advance approvals are done a lot faster.
3. Facilitates Business Growth
Businesses need a steady cash flow if they’re going to experience any growth. Factoring is an enabler for business growth because it allows businesses to extend credit lines to their most loyal customers.
It also allows businesses to pay employees and suppliers, allowing the business to stay productive and avoid challenges in its supply chain.
Factoring provides businesses with the opportunity to transform unpaid invoices into working capital. They can use the working capital to fund business activities such as expand their marketing activities, invest in company assets, or hire additional staff to meet growing demand.
4. Factoring Is Affordable
There exists a widely held stereotype that factoring is expensive and is only restricted to businesses with financial muscle. While there might be a bit of truth behind the stereotype, the fact is factoring fees have reduced dramatically in recent years.
The costs of factoring can go as low as 0.5% of a company’s business volume depending on the factoring company and the industry.
5. Allows Business Owners to Focus More on the Company
As explained above, invoice factoring allows the business to hand over credit control functions to the factoring company. This provides business owners with a few significant benefits, not least of which is the flexibility to focus on other core functions of the business.
The business owner can dedicate more resources and attention to marketing, streamlining business activities to increase output and make it more efficient, or expanding their customer base.
6. Save Money and Time
Keeping track of unpaid invoices and constantly following up on client payments can be very expensive and time-consuming. By outsourcing these functions to a factor, you will take a big task off your plate, allowing you to free up valuable company resources.
Since debt collection is a free service provided by factoring companies, you’ll have more money to pay for other business functions that are in more urgent need of money.
7. Reduced Risk of Bad Debts
A business that offers credit facilities to its customers faces the risk of late payments from clients or even clients failing to pay altogether, leading to bad debts for the business.
Yes, a business can take legal action against clients who fail to pay their invoices but consider how long the process can take as well as the cost of hiring a legal representative. Fortunately, factoring can help companies avoid such undesirable scenarios.
Factoring companies have professionals who are well-trained and experienced with dealing with clients who are unwilling to repay their debts. Through non-recourse factoring, businesses are protected from incurring bad debts because they yield all liability for unpaid invoices to the factor.
However, since non-recourse factoring bears more risk to the factoring company, the factor will give more consideration to the creditworthiness of the invoiced client. Non-recourse factoring fees are also higher as compared to the less risky option which is recourse factoring.
With recourse factoring, the business is meant to pay back the cash advance in case the invoiced client fails to pay.
8. Flexible Financing Option to Other Alternatives
For small businesses and startups, accessing financing from lenders such as banks can be difficult. A lot of mainstream financial institutions often prefer working with established brands and companies when it comes to business financing.
But with factoring, businesses of any size can access the financing they need to sustain their operations and keep their doors open. Factoring companies are less demanding when providing financing. There’s not a lot of paperwork required and they don’t consider the net worth of the business but rather, the ability of the business’s customers to pay their invoices.
Factoring companies also don’t require the business to give up any equity as venture capitalists often demand. Factoring provides financing while allowing the business owners to retain full control of their company.
9. Choose How Much You Need From Factoring
Factoring allows businesses to choose how much money they need to access from factoring unpaid invoices as well as how many invoices they want to factor.
Compared to traditional financing options where the creditor may decide to offer a subsidized amount of what you’d initially applied for, factoring will give you a cash advance worth almost the same amount they need from factoring.
Invoice Factoring Is the Way to Go
The importance of sufficient cash flow to a business’s capability to maintain operations cannot be stressed enough. Businesses require money to fulfill orders and expand their customer database.
If you want to take up factoring, the factor you choose to work with is very important. Consider their reputation, rates, and experience in your industry. What types of invoice factoring do they provide? Are there any hidden charges?
Make sure you ask these questions during the vetting process to get the best factoring services provider for your business needs.