The Pros and Cons of Invoice Factoring
What is Invoice Factoring?
Unlike a business loan, invoice factoring creates an increase in cash with money that’s already owed to your business. The basic process is simple; you sell your outstanding invoices to a factoring company that pays a lump sum, usually between 70 and 90 percent of the invoice total. Then, you can use this money immediately for working capital.
The company will charge a fee for the service, often a percentage of the invoice amount. Then, the task of collecting outstanding invoices then belongs to the factoring company.
Pros of Invoice Factoring
- Immediate cash flow – When applying for business loans or other financing options, it can take months to be approved. In comparison, invoice factoring gives you access to cash quickly, so you can keep your business running smoothly.
- Ongoing cash flow –Invoice factoring doesn’t need to be a one-time financing option. You can build a relationship with your factoring company that will continue if it makes sense for your business. Maintaining cash flow won’t be a problem because you won’t have to wait for invoices to be paid before you have money in your account each month.
- Better approval chances – Collateral, credit score, and loan history aren’t major factors in determining your ability to use invoice factoring. The invoices themselves act as collateral. Typically, the factoring company will be most concerned with looking at the payment history of your customers. This gives them a good idea of what kind of risk they’re taking on.
- Outsourcing – Keeping track of outstanding invoices and contacting customers is time consuming. Due to this, giving those tasks to another company will take a major task off your plate. You’ll have more time to deal with day-to-day tasks, while the factoring company will set terms and contact customers for payment.
- Customer Relationships – Some of your responsibilities as a business owner can be frustrating and difficult. Debt collection is one of those tasks. By handing over this responsibility to a factoring company, you don’t have to look like the bad guy when it comes to collecting money. This can help maintain strong, positive relationships with customers.
Cons of Invoice Factoring
- Cost – The fees associated with invoice factoring could be limiting. Typically, a factoring company will charge between 1 and 5 percent of the total invoice amount in service fees. You’ll need to decide if the tradeoff for immediate cash is worth the loss.
- Liability – You may be responsible for unpaid invoices. Keep in mind that invoice factoring companies don’t act as collections agencies. They most likely won’t put in extra time to track down late paying customers who don’t meet the terms of their agreement. If you have a recourse invoice factoring agreement, you’ll be responsible for paying for those unpaid invoices, or trading in a different invoice of the same amount to cover the cost.
- Dependency on customers – When determining eligibility for invoice factoring, the company will look at your customers’ payment history to calculate the risk of taking on your invoices. If your customers have a habit of not paying you on time, the factoring company will assume they won’t be paid on time either, and will be less likely to take on your invoices.
- Lack of control –Invoice factoring involves handing over complete control of your invoices to another company. You’ll need to make sure that you’re comfortable with that company and their practices before taking that step. If you choose a reputable company, you should be able to trust that the process will go smoothly.
Conclusion: Is Invoice Factoring Right for Your Business?
Not every financing solution works well for all small businesses. Invoice factoring works well for business owners that need money quickly, have reliable customers that have a history of paying invoices on time, and can afford the fees that come with selling invoices to a third party. If this sounds like your business, you might benefit from an invoice factoring solution!
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.