Many small- to medium-sized businesses struggle with cash flow due to slow paying customers. Waiting too long to get paid or lengthy payment timelines can hamper business growth. You can’t move your business to the next level without having the needed working capital on-hand to do so.
Invoice factoring, also known as factoring accounts receivables, is an alternative commercial financing solution that is well-suited to businesses facing customer payment delays. With factoring receivables, businesses sell their valid invoices to the invoice factoring company for an advance payment. They collect the bulk of their invoice total in a matter of days thereby eliminating the wait that comes from customers who are too slow to pay. With this money in hand, business cash flow and working capital are restored. Capital from factoring invoices can be used to increase production, expand into new territories, hire new staff or meet debt obligations.
Factoring offers many benefits but read the fine print
Though invoice factoring offers many paybacks, it is no panacea to all business aches and pains. It comes with its own guidelines, best practices and limitations. Like all business financial solutions, those considering factoring receivables need to learn about what factoring is, what it entails, and how it works. This often means reading the fine print, asking smart questions, and doing your own due diligence before jumping onboard with an invoice factoring company.
Here’s the most common oversights related to invoice factoring:
> Not understanding all costs and fees
The total cost of using factoring services can vary from firm to firm so it is a good idea to search around on prices and to do a comparison. Generally, factoring companies charge a weekly percentage fee for their services. This means the longer it takes for them to collect on the invoice from your customer, the more you will have to pay in fees.
In addition, some firms may charge other fees such as installment fees, application processing fees, handling fees and more. Make sure you familiarize yourself with all costs and fees involved so you know what you are getting into before signing the contract. This way, there are no surprises in the bill and you can plan your budget accordingly.
> Not reading the contract requirements
Many factoring companies require you enter into a contract with them. Though terms may be flexible if you search around at different companies, many will require a 6-month or 12-month commitment. Some may allow you to skip a month or two during a non-busy season but you will have to negotiate this in advance. If you are seeking to use factoring as a one-time thing, you can set this up with the factoring company as what’s called spot factoring but again, this generally needs to be arranged in advance.
To avoid getting yourself in a bind regarding your commitment to the factoring company, make sure you read the contract and ask questions before signing. Again, this is true with any and all financial commitments you make on behalf of your business.
> Poor information gathering and documentation
When you first apply to the factoring company, you will be asked to complete an application, gather some business documents, and sign some paperwork. You will also have to answer some questions pertaining to your business, its customers, your bank accounts, etc. These questions may pertain to any current or previous liens on the business, bankruptcies, financial debts or any other obligations or commitments.
While this is standard operating procedure, some applicants may not completely fill out the application or forget to list a current lien or debt. Incomplete or incorrect information on the application will most certainly slow down the application process. If you are seeking to sell your invoices for immediate cash, not having your documents and information together will hinder the account receivables factoring processing. Moreover, your application could be denied.
> Not choosing the best customers’ invoices for factoring receivables
As was mentioned previously, the longer it takes for your customers to pay their invoices, the more fees you will pay to the invoice factoring company. As such, you should try to choose customers that tend to pay their bills on time at 30 days or less. A customer that has a history of erratic payment may not be the best one to candidate for factoring.
> What do your invoices look like?
Are your invoices easy to read and understand? Are they current and up-to-date? Is it easy to discern how much is owed and when it is due? These sorts of oversights can delay the invoice factoring process as well as delay customer payment timeline.
> Incorrectly directing payment
Generally speaking, standard practice with factoring receivables is that the customer or the debtor remits invoice directly to the factoring company during the usual 30-day payment window. Therefore, you may have to redirect payment from the customer to go directly to the factoring company. This is usually a simple process that may involve sending a piece of correspondence or email. Either way, it still needs to be done or else the factoring company won’t receive payment on time and you may have to pay additional fees.
While factoring receivables has many benefits to small businesses, it is important to understand the terms of the factoring agreement before proceeding. In this way, applying for receivables factoring is the same as applying for a business loan in that you need to read the fine print before signing the contract.