Find out all about invoice factoring, and whether it is a good fit for your business needs.
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With invoice factoring, you’re selling your outstanding invoices - or accounts receivable - to a factoring company (the factor).
Here’s an overview of the factoring process: firstly, the factoring company will advance a lump sum to your business. The advance will vary across different factors, but is typically 70 to 90 percent of the total invoice value. The remaining amount, known as the reserve will be paid out (less the factoring fees) once your customers have paid up the invoices in full.
The factoring fees typically includes a three percent processing fee, along with a factor fee that ranges between one to six percent of the total amount due.
Invoice factoring vs discounting
It’s easy to get confused about invoice factoring and invoice discounting, as both these financing solutions are based on outstanding invoices. The key difference between these two forms of invoice financing is that factoring involves the sale of your invoices to a third party, while with invoice discounting, your business retains control over your accounts receivable and payment.
Invoice factoring is best suited for addressing short term financing needs, such as covering unexpected costs, inventory purchases or cash flow gaps. It’s not intended for financing large scale investments, such as a major renovation project or equipment purchase.
The following are general requirements that can help you assess if factoring is a good fit for your business:
You require funding quickly: With invoice factoring, you’ll be able to free up capital that would otherwise be tied up in unpaid invoices for 30 days or longer. And depending on the factoring company of your choice, you could obtain financing as soon as within a day or two from your application approval. As such, factoring lends itself well to small business owners in need of immediate funding.
You can count on your customers that pay up on time: Your customers’ ability to make timely repayments can have an impact upon two areas: your eligibility for invoice factoring, as well as the total factoring fees that you’ll be charged. Firstly, you’ll stand a good chance at getting approved if your customers are established ventures with good credit scores; if they have a less than stellar payment history, it’s unlikely that the factoring company will take on your invoices. And as the factor fee is charged for every week the invoice is outstanding, you may wind up paying a sizable sum in factor fees if your customers are slow to pay up.
You don’t have an established credit history: Factoring companies are most concerned about reviewing the payment history of your customers; factors that are used to assess a borrower’s eligibility with other loan types, like operational history or credit score don’t weigh as heavily on their decision to take on a business’ unpaid invoices. As such, invoice factoring can be a viable option if your business doesn’t have a solid credit record or aren’t able to qualify for other financing solutions.
You’re willing to collaborate with a partner in your accounts receivable and debt collection process: While the extent of customer contact will vary across factoring companies, it’s still an aspect that small business owners are concerned about when it comes to invoice factoring. They want to maintain positive relationships with their customers - and as such, may be concerned about bringing on a third party company who will interact with and collect payment from their customers. If invoice factoring is an option you’re considering, you’ll need to be comfortable giving up a certain amount of control with regards to your accounts receivable and debt collection process.
Pay attention to repayment terms and hidden fees
As with any kind of external financing you choose to take up, it’s important to pay attention to the repayment terms, and be fully aware of all possible fees you may be liable for. With invoice factoring, these are some of the terms and hidden fees you’ll need to pay close attention to:
Know the difference between recourse and non-recourse factoring:You may be responsible for unpaid invoices, depending on whether you’ve opted for recourse or non-recourse factoring. With recourse factoring, you’re required to purchase unpaid invoices, or have the amount owed deducted from your reserve in full or in installments until it is fully paid up.
Read the fine print: A low factoring fee can be attractive - but make sure you’ve gone through the fine print in detail to make sure that the factoring company doesn’t have other fees that they might charge in addition to the factoring fee. Always request for a full breakdown of the fees involved, and keep an eye out for factoring charges such as: origination fee, incremental fee, service fee, collection fee, overdue fee, unused line fee, renewal fee, ACH transaction fee, wire fee, credit check fee, termination fee and the monthly minimum volume fee.
Obtaining external financing from banks and traditional lenders is often an uphill task for small business owners due to the stringent lending criterias imposed. This may range from having a minimum annual revenue of $200,000, a solid credit history or a minimum operational history of two or three years.
But traditional lenders aren’t the only options available. Depending on your business needs, invoice financing can be a viable option. With online lenders like Aspire, small businesses like yours will benefit from the flexible lending criterias, quick access to funding and streamlined application processes.