Is your business growing faster than your cash flow can accommodate? Do you have a company expense due that simply can’t wait until your next influx of cash?
Invoice factoring could be the solution you need.
Read on to learn more about what invoice factoring is and how it can work for you.
How does invoice factoring work?
Invoice factoring services (or “factors”) provide businesses with quick cash by advancing them their own future income. Companies who are waiting 30, 60, or 90 days for customers to pay on invoices can get most of that money within a few days. They do this by selling their accounts receivable to a factoring service at a discounted rate.
Unlike bank loans or credit cards, invoice factoring can get you quick access to cash without taking on any long-term debt.
The process is pretty simple:
- Your company sells short-term debts owed to you by your customers (invoices not yet paid) to a factoring service.
- You are quickly paid (typically within a few days, sometimes as soon as 24 hours) an advance on these invoices. The amount of your advance can vary, but most companies pay out 80-85% on average. Depending on the industry, it can range as wide as 65-98% of the amount due.
- When your customer pays the invoice, the money is collected by the factoring service. At this point, the remainder due to you (the “reserve”) will be paid out, minus any interest and fees charged by the factor.
Different types of factoring services
Depending on your individual needs and which factoring service you choose to work with, there are multiple invoice factoring options available:
- Recourse factoring
- Non-recourse factoring
- Spot factoring
- Contract factoring
- Notification factoring
- Non-notification factoring
This option does carry a degree of risk. Invoice factoring generally should be used with invoices of customers who have a solid track record of repayment. This becomes an especially important consideration when using recourse factoring.
With recourse factoring, if your customer does not pay their bill on time (or at all), you will be responsible for paying the money you were advanced back (in addition to any fees incurred) to the factoring service.
That being said, recourse factoring is usually more cost-effective and easier to obtain than non-recourse factoring.
With non-recourse factoring, the factoring service accepts the risk of the customer not paying and will not require you to pay it on their behalf if they default.
However, many factoring service contracts will include select instances in which “non-recourse” would be rendered invalid, leaving you subject to partial or full recourse, after all. Do be sure to review all of the fine print before selecting your factor, even if they advertise themselves as “non-recourse.”
The most flexible option to leverage your accounts receivable is spot factoring. This method lets you select which invoices you wish to factor and when. Even if you only need a one-time advance drawn on a solitary invoice, spot factoring is an attractive option.
Contract factoring, an alternative to spot factoring, requires you to provide the factoring service with specific quantities of business. For example, a factor may want to service every single invoice from a particular customer, or a certain percentage of your monthly total invoices.
When the factoring service takes control of the entire billing and collections process, including communication with your customer, it is called notification factoring. All bills, collection calls, and so forth will come directly from the factor. The factor will send your customer a notice of assignment as soon as the debt is purchased, letting them know the debt has been transferred and where to send payment.
With non-notification factoring, the factoring service still handles billing and collections but keeps communication with the customer in your company name. When the factor sends a bill, for example, they may list their own P.O. box as the remittance mailing address, but use your company name as the addressee. Likewise, with collection calls, their personnel may introduce themselves as calling from your company’s billing department.
Who is eligible for invoice factoring?
Invoice factoring is generally available to:
- Companies that sell to other businesses or to the government
- Companies with invoices due in 90 days or fewer (Creditworthiness of the customer owing the debt is researched before a factoring service will agree to purchase it)
- Companies with no major past or present tax or legal problems
Of course, individual factoring services may have additional requirements of their own, such as your own creditworthiness or length of time in business.
How much does invoice factoring cost?
The cost of invoice factoring can vary widely. The debt you are selling to a factoring service is going to be subject to a “discount rate” of anywhere from 1.5 – 7% (per month) of the invoice total until the customer pays.
Additional fees may be charged by your particular factoring service for applications, credit reports, notification expenses, late payments, etc.
Factoring companies vary by industry
The basic principles of invoice factoring are the same across all industries, but the reasons, risks, prices and details do tend to vary. That’s why many factoring services have elected to narrow their focus to just one industry (or a few).
For example, trucking factoring companies will get freight bills paid right away. This frees up cash to keep trucks in good working order, gassed up, manned with drivers, and carrying new loads of freight. Trucking factoring companies help independent truckers and large fleet companies alike.
There are a number of other industries that also benefit from industry-specific invoice factoring.
Here are a few examples:
- Food and beverage
Whether it’s to purchase raw materials, update equipment, or make payroll, each of these industries requires spending some money to stay in business. Invoice factoring can give these companies peace of mind, knowing that the cash will be there when it’s needed – instead of two months later.
Is it right for you?
Invoice factoring is a great tool to have in your back pocket.
You can use it to:
- Survive a rough patch
- Take company growth to the next level
- Outsource the billing process
- Pay for a one-time large expense
As with any financial product, there are inherent expenses and risks. Careful selection of a factoring service and contract that meets your specific needs is a must.