Invoice Factoring

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.

Invoice Factoring: Some Basics

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.

What Happens If They Cannot Collect on An Invoice?

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.

Benefits of Invoice Factoring

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.

  1. It is not a loan. Invoice factoring is not a business loan per se; that is because there really is no loan repayment involved. For many business owners, this makes factoring a desirable option. Basically, as you are selling your unpaid invoices to a factoring company, you will receive payment for those invoices and this in turn represents the bulk of the transaction. Granted, there is money left on the table which you do receive once the invoices have been paid (minus the factor's fees), but in the short term, you receive a much needed infusion of cash to the business.
  2. You do not need stellar credit to qualify. For many newer, smaller companies this is a tremendous reason to go with invoice factoring. You don't necessarily need the best credit score, nor do you need to have five plus years in business. The invoices themselves become the security. And again, because this is not a loan, the invoice factoring company is actually not as interested in your credit history as they are in that of your clients. Remember, they make their money back by being able to collect. If your clients' credit scores are subpar and their credit history less than ideal, the factoring company will be less inclined to want to buy your unpaid invoices as their chances of successful collection will seem slim.
  3. The process is very fast. It often happens that a small business will need additional working capital and they will need it quickly. Applying for a business loan through a traditional bank can be a time consuming and tedious process. With invoice factoring, the numbers and needed information are rather cut and dry—either you have good invoices to sell, or you don't. Once the company does determine that your invoices are worth buying, the funds can be in your account in as little as two to five days in most cases.
  4. You free up time to focus on more important issues. Just think about how much time and energy it takes to chase after unpaid invoices. The phone calls, the emails, the reminders, it can seem downright overwhelming at times. You're selling those unpaid bills to an invoice factoring company, and so you are putting the burden of collection in their laps. They are the ones doing all of the running and chasing and thereby freeing up your time to focus on other business related matters such as growing your business, finetuning your processes and revisiting your budget, among other such tasks.

Some Cons to Consider with Invoice Factoring

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.

  1. Are your invoices good? An unpaid invoice is an unpaid invoice, right? Not necessarily. The factoring company remembering is trying to mitigate their overall risk when considering whether or not to buy your invoices and consequently how much they are going to charge you by way of their cut. This is why they do their due diligence when it comes to evaluating the quality of your invoices. Are your clients worth the risk? In other words, what is their chance of actually collecting the money owed? If the bulk of your clients have below average credit and weak credit histories, the invoice factoring company is likely to reject your invoices. Additionally, how old are your invoices? Generally speaking, factors and factoring lenders like to see invoices that are between 30 and 90 days old. Anything beyond ninety days is usually considered uncollectable and thus not worth the risk on their part.
  2. There is the fee. While again, the factor is taking work off of your plate by tracking down those non-paying customers, they do charge for it. The more of a risk your invoices seem to be, the more you will get charged. For some small businesses, the cost of working with an invoice factoring lender is worth it; for others however, it may be too steep a price to pay as they are relying upon every penny. The company therefore may be more apt to try and continue to collect the money on their own and thus not have to pay out to a factoring firm.
  3. You may not have enough in outstanding invoices. The invoice factoring company is making an investment. Just like any other company, they are in business to make money. If the amount of unpaid invoices you have is too small, it will likely not be worth their time or effort to go after the non payers on your behalf. Your company needs to have a relatively sizable amount of unpaid invoices in order to be able to come to an agreement with an invoice factoring company.
  4. You could jeopardize customer relationships. Keep in mind, the invoice factoring company has no established relationships with your customers. They may take a more aggressive approach as they are only interested in collecting on the debt and recouping the money they paid you for that invoice. This is likely to anger your clients and could effectively end the relationship. It is worth considering however, how important that particular relationship is. If the customer is late in paying, particularly if they are habitually late, is this actually a customer that you want to keep doing business with?

Invoice Factoring vs. Invoice Financing

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.

First Union Is Here to Help

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.

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