It is a fact that running a business venture comes with many challenges. At the top of the list are money-related problems. Cash flow problems are the cause for stagnating. Sometimes these arise from non-paying clients or those who take 30, 60 days. What happens in such a case if the business can’t afford a bank loan? That’s where invoice factoring can save the day. Small businesses can benefit from learning about this funding option and how to leverage it on rainy days. Here is a simple breakdown of how it works.
About Invoice Factoring
Invoice factoring or invoice discounting is a financing option where a business accesses cash using an unpaid invoice. It works by a business owner selling his invoice to a factoring company at a discount. The company assesses the credibility of the customers in the invoice. If they are viable, it avails the business owner cash flow. The factoring company will then collect payment directly from the customers. The advantage of invoice factoring is the seller doesn’t have to wait too long for the funds.
This finance option is popular with SMBs because they may not have the capacity to wait for late-payments, and their ability to access loans is more limited than that of large corporations. How do they ensure they qualify for this one?
The first step is to make an application to a factor. The factor will review and determine eligibility.
The review involves a background check of the customers to determine:
- How long it takes before they pay for products
- Records with other businesses. For instance, how they pay bills and government services.
- Their credit score
- How they earn income
- Any possible legal issues or debt
- Once the factor determines that the customers check these boxes, they will accept the application and initiate the contract process.
Is It a Viable Funding Source
When a company needs immediate cash, then factoring the invoices is as good an option as any. Although they will be getting at a lower rate than the actual sale price, it helps businesses avoid the trap of getting into debt and loans.
The business owner doesn’t have to wait for payments from customers. He can keep running the business and sort out any immediate issues like payroll, inventory purchases, and other recurring expenses.
The business shifts the responsibility of follow-up to the factoring company. It can therefore focus on running the enterprise.
Possible Costs of Invoice Factoring
Like any business transaction, the factoring companies have to ensure they make a profit from their service. The profit comes in the form of charges and costs of purchasing an unpaid invoice.
These will vary from company to company, so it’s necessary to find out with the factoring company in question.
These are some of the costs factoring companies may charge.
Although not applicable for all companies, an application fee is an upfront amount for registration and due diligence. Companies that do not charge application fees can have higher factoring fees.
It is a charge for paying for an invoice in advance. Factoring companies consider it a risk fee on their part.
A charge may apply if a business decides to end the factoring agreement early.
It is an amount business owners incur for invoices that take longer to fulfill. For example, if the agreed-upon time for payment was 30 days and extends, the company charges a fee for this delay.
How to Choose a Factoring Company
When searching for a factoring company, there are screen potentials to avoid surprises during the business relationship. Some bases to cover are
How long the company has been in business is a factor to consider. Older companies have more knowledge and capital base. It will mean fewer restrictions for the business owner.
Reputation tells a lot about how a business operates. Companies with a good one indicate better standing with clients. They are the ones worth checking.
More important is the service charges. Look into the types of fees they charge under various circumstances. These include recourse and non-recourse fees, discount fees, etc.
Invoice factoring is a great way to access funds for small businesses. And also, stay debt-free. If taken with caution, it can help SMBs survive and scale.