Regardless of the industry, no business large or small can survive long without a steady, reliable cash flow. Every business depends on cash coming in from the sale of their products or services in order to meet inevitable expenses, including payroll, the purchasing of equipment and supplies, commercial property rent, etc. When cash flow issues arise, many businesses may be faced with the challenge of survival.
This problem is complicated—for both B2C and B2B businesses—by a willingness to agree to generous payment terms requested by their clients. Invoices may be outstanding for 30, 60, or even 90 days before payment is delivered. What happens while businesses await payment? Operational debts go unpaid, opportunities to expand are put on hold or a star employee decides to leave because of issues with payroll.
There’s simply too much at stake for businesses to risk waiting for delayed or late payments on their invoices. Fortunately, a solution is at hand, in the form of invoice factoring.
What is invoice factoring?
Invoice factoring (also known as “invoice financing,” “accounts receivable financing,” and “receivables financing”) involves selling invoices to a factoring company in exchange for immediate cash. In essence, the factoring company serves as an outsourced credit and collecting agency, assuming the task of collecting and processing those invoices, so a business doesn’t have to waste valuable time on invoice administration and collection calls.
Depending on the terms invoked by various invoice factoring companies, a business can be charged a flat fee per invoice or a percentage fee, relating to the length of time required to collect payment on an invoice. Others also charge an application fee.
“You don’t get the full amount of the invoice, as some of the money goes to the factoring company to cover fees,” notes Meredith Woods at Fundera. “What you do get, however, is an immediate advance, as opposed to waiting around to be paid. For companies that need cash flow now, not later, this is just about as good as it gets.”
Which businesses benefit from invoice factoring services?
Not every business is right for invoice factoring, though a great many are. It’s most appropriate for B2B sales, invoicing with payment terms of between 30-120 days, and businesses that operate on a “final sales” basis (as opposed to sales based on contingency or consignment). Among the industries for which invoice factoring is best:
- Professional services
- IT companies
- Wholesale trade and manufacturing companies
- Distribution companies
- Businesses in trucking and transportation
- Oil and gas companies
- Public relations firms
- Staffing companies
Steve Nicastro at NerdWallet offers this example of the benefits of factoring receivables: A hardwood store sells products to a client, resulting in an invoice of $10,000. An invoice factoring company purchases this invoice for $9,700 (minus their 3% factoring fee of $300) and advances 85% of the invoice ($8,245), “although the actual size of the advance will depend on numerous factors, including the total amount of the advance, the age of the invoice and the customer’s creditworthiness.” After collecting the invoice, the factoring company advances the reminder of the balance owed to the hardwood store ($1,455), minus any residual, agreed-upon fees for services.
With the immediate cash in hand, the hardwood store is well-positioned to take on additional projects, hire more staff, purchase inventory, etc.—opportunities that might not exist if the hardware store was forced to wait additional days or weeks (or even months!) for payment.
How the process works
If invoice factoring looks like a good fit for your business, here’s a look at how the process typically works:
Start with a business representative. An invoice factoring representative evaluates your outstanding invoices and helps you select the most appropriate factoring service for your business.
Fill out an application. Unlike a typical bank loan application, this application generally takes under 15 minutes to complete. Invoice factoring companies usually focus on your client relationship history, rather than your personal or business FICO score. (This represents a key difference, and benefit, from bank loans.)
Processing information. Upon receipt of your application, the factoring company processes the information, taking into account the needs of your business to purchase invoices in the fastest possible amount of time. Your business representative and the factoring company will then advance as much as 96% of the total amount of the invoice to your business.
Receiving funds. With help from your business representative, you will get your funds in a way that’s best for your needs (typically in the form of direct deposit). The money is yours to spend as you see fit; the factoring company has no influence on your decision.
Client payment. Your clients do not pay invoices to you, but rather mail them to the factoring company in charge. Upon receipt of payment, the factoring company deducts their fee and rebate difference and delivers the balance to you.
In many cases, industries are already familiar with the invoice factoring process. This can “put a potential factoring client at ease, knowing their customers will not be caught off-guard by the 3rd party collecting payment for their unpaid services.”
Weigh the advantages and disadvantages
As noted, factoring receivables isn’t necessarily the best option for all companies. When making your decision, be sure to weigh the advantages versus the disadvantages, including:
- Enhanced cash flow
- Quick access to urgently needed cash
- No collateral needed (invoices serve as collateral)
- Simpler approval process
- Collection services also available to your business
- Your credit worthiness is not the key element, as with a traditional bank or financing loan.
- Sacrificing a portion of payments from your clients
- Customers who are slow in payment can impact the amount you owe to a factoring company.
- Some factoring services may charge for hidden costs (application fees, processing fee for every invoice financed, credit cheek fees, overdue fees).
Nothing is more crucial to the growth of your business than strong, dependable cash flow. If your clients are consistently late in payment, this could be the right time to take a closer look at the options and benefits offered by invoice factoring services. In the end, it could mean the difference between slow and obstructed growth or an exciting opportunity to take your business to the next level.