What is Invoice Factoring?
What could potentially be hurting your company financially? Well, there are numerous things that could contribute to a business's negative cashflow position. From unexpected (and large) expenses popping up, to your hours and capacity being restricted due to a worldwide pandemic, to one of the most common reasons why a business may experience a decline in cashflow: people failing to pay on time—or in some cases, at all. While you've built your business around your customers and you try and adhere to the dictum that the customer is always right, sometimes an issue can arise with one or more of those customers. Their payment may not exactly be forthcoming. It does happen. And when you are counting on the money from sales to get you through a certain period, a late or non-paying customer can certainly throw a wrench into things.
Fortunately, there are steps you can take and solutions available that can help you to both collect the money owed you and also to help boost cashflow in the interim. Invoice factoring has saved many small businesses across the country during those slower, more difficult times. Not to mention, invoice factoring has enabled them to collect on invoices where perhaps they may have resigned themselves to the fact that the money owed for a good or service was simply never going to come.
When you do enter into an invoice factoring deal, you are essentially working with a lender/company that specializes in factoring. They in turn will collect on those unpaid invoices on your behalf. This is because your small business will have sold unpaid invoices to the lender in return for a lump sum--minus their fee. Their fee can be anywhere from two to five percent on average, though some factoring companies may take more. Initially, they will give you a percentage of the total unpaid invoice amount, typically 80-90%. You will get the remainder once they've successfully collected on the invoices.
In this article we break down the invoice factoring process and weigh the pros and cons. Invoice factoring may not be for every business. The key is to determine whether or not it actually makes sense for your company.
As mentioned, when you are thinking about invoice factoring, the important thing is that you actually have invoices, and what's more, invoices that are likely to be paid. An invoice could be sixty days overdue, but if the factoring company deems it a good risk, this unpaid invoice could then be worth money. It really does come down to the credit risk that the invoice factoring company is taking—on both you and the clients with overdue bills.
After selling your past due invoices to the factoring company, the factoring company gives you a lump sum payment of the total amount sold to them. This could range from 80 to 90 percent of the total value of all invoices. There is also a fee charged on the part of the factoring firm. As noted, this fee will generally fall somewhere in the two to five percent range of the total invoice value.
Once you've sold your invoices, it then becomes the mission of the factoring company to collect on them. You receive the remaining balance of the total invoice value once they are able to successfully collect the monies owed. Keep in mind, if the process drags out and the invoice factoring lender is not able to collect in a timely manner, you will be charged. Usually, this penalty is charged monthly. So for every month beyond the stipulated date that the invoice remains unpaid, your company gets charged a certain percentage. This means that when the factoring company does eventually collect, the remaining balance you receive will be less than anticipated.
If let's say, after a sixty day period the invoice factoring lender cannot collect on an invoice, they will ultimately come back to you. You will then be responsible for paying back the money already lent on that invoice plus any penalties and fees that the factor charges. This is what is known as the recourse method.
There is also non-recourse factoring. In this scenario, you are not liable even if the factor cannot collect on the unpaid invoice. However, keep in mind with the non-recourse method the factoring company will generally charge more by way of their fee. And in some instances, you can still be on the hook for the money. This is why you want to carefully review the fine print.
So why go this route? If your small business needs an influx of cash, why choose invoice factoring over a short term loan, line of credit or some other such financing option? There are a few notable benefits when it comes to invoice factoring that for small businesses especially can make this an attractive choice as far as raising additional working capital.
While going this route can be beneficial to many small businesses, there are going to be times when it may not make the most sense. You really have to look at a variety of elements before pulling the trigger on invoice factoring.
There is a difference between invoice factoring and invoice financing. With invoice factoring there is no loan involved per se. Rather, you are selling something (your unpaid invoices) to a company and as they collect on those invoices you get the remainder of the money owed you. With invoice financing however the process works a bit differently.
When it comes to invoice financing, you are responsible for collections. That is to say, the invoice financing lender is not going to go out on your behalf and track down the unpaid funds—this is still your job. They instead are giving you a lump sum based upon the value of your invoices (and using those invoices as the security on the loan) and then as you collect the money, you pay back the cash advanced to you by the lender. This type of financing is very much a loan.
If your small business is in need of additional capital, there are a variety of options open to you. First Union specializes in helping small businesses get the cash they need when they need it—not weeks or months from now. With short term loans, SBA loans, merchant cash advances, among other products, we have a financing solution perfect for you. And most of our clients receive the money in their account within two business days; we really do work that fast. Call today and let's get started together.