The strategies for balancing uneven business cash flows can take multiple forms, and among the available options is factoring. Simply put, when the outstanding invoices of a business are bought off by a third-party called a “factor” or “factoring company”, the process is called invoice factoring. Such a firm typically charges a factoring fee fluctuating between 1% to 5% of the total invoice value. Factoring is designed as a method to safeguard credit scores while providing financing to businesses during cash crunches.
However, before enrolling for invoice factoring, there are some aspects to more closely consider.
What is Invoice Factoring?
Invoice factoring refers to the sale of unpaid invoices to another company to reduce debt and cover the cost of maintaining the business while waiting for payment. The sale of unpaid invoices allows small businesses to recuperate debts quickly. This is especially important for companies that are experiencing bad credit.
The company that purchases the invoices is called a factoring company. It is as though the factoring company was lending you money based on your outstanding customer invoices. Some of these invoice financing companies also offer invoice discounting and secured lending.
What You Need to Consider Before The Process?
Invoice factoring is ideal for startups and entrepreneurs because it helps maintain positive cash flow without negatively impacting creditworthiness. By definition, factoring saves time and resources by letting a third-party company chase the outstanding invoices in return for immediate cash. Given that a large number of factoring companies also possess resources to get in touch with the customers who owe outstanding, they assume the power to levy the due payments directly. Besides these pros of factoring firms, there are key elements to consider before determining factoring is the right fit.
How Big Are The Financing Needs?
Because most factor companies offer varying advance percentages on the basis of outstanding invoices, borrowers will ultimately lose a small percentage on every invoice. Prior to registering with a factoring firm, it is recommended to calculate the advance percentages of shortlisted vendors based on the receivables.
This gives a general idea about advance amounts offered by different financiers so that borrowers can compare the potential cash advance with the total cash needed. Keep in mind that most factor firms approve invoice factoring requests in 1 to 5 days.
Is Invoice Factoring Appropriate?
Businesses that would ultimately be aided by invoice factoring include those with multiple outstanding invoices expected to clear after long intervals. It is especially recommended for businesses in need of urgent funds due to substantial delays between recording a sale and receiving customer payment. For businesses that encounter much shorter turnaround times for payment and receipt of payment, factoring may not be the most appropriate solution. It is more valuable for those companies operating on a 30, 60, or 90-day payment interval.
How Will Creditworthiness Impact Factoring Terms?
When it comes to invoice loans, the poor credit score of the business does not negatively impact factoring. On the contrary, an invoice factoring company focuses on the credit scores of a business’s customers and their relationship with the business to determine the factoring rates and terms for factoring cash advances.
Moreover, procuring immediate cash from outstanding invoices can also aid on-time debt repayment and thus help improve credit scores.
What Documents Will Be Needed To Apply?
An invoice factoring company will require submission of the following obligatory documents to apply for factoring.
- Company Documents – This may include articles of incorporation, company identification documents, corporate tax returns, and licenses that are mandatory for verification.
- Accounts Receivable Aging – Consists of reports listing unpaid invoices and outstanding credit balances by timeline.
While the quick cash available from invoice factoring can be beneficial when accessing financing is critical, it is imperative to assess whether the fractional loss is enough to compensate for slimmer profit margins and potential earnings. To successfully engage in factoring, ensure it is a suitable option and the business meets the important criteria for eligibility to maximize any available benefit.