Does your business operate using invoices? Have you experienced times of short cash flow due to unpaid invoices? If this sounds like your company, then it might be time to consider invoice factoring. Also referred to as "invoice financing" and "accounts receivable financing," this form of funding allows business owners to get the money they need from their customers' unpaid invoices.
With the help of a factoring company, you can get an advance based on your invoices, which allows your company to continue operating smoothly. It's one of the many resources that both a small business and larger company can use when looking for the proper funding.
What Is Invoice Factoring?
Invoice factoring allows businesses to use their outstanding invoices as collateral. You can trade your unpaid invoices for a loan, allowing you to have working capital. If you are having trouble finding funding from a traditional bank and your business utilizes customer invoices, invoice factoring could be a great tool.
With financing and invoice factoring, there are some fees to be aware of. Typically, any invoice factoring agreement will come with processing fees and factoring fees. Any additional finance fees will be laid out in the contract. Companies that need money for taxes, making payroll, an upcoming project, or other resources can all utilize invoice factoring.
For roughly 85% of the total statement amount, you can get cash fast. The remaining 15% is held in reserve by the invoice factoring company. A portion will be returned to you, and the rest is subject to the fees mentioned above. Most fees are calculated weekly and depend on how long it takes the customer to pay.
Why Choose Invoice Factoring?
There are two main reasons why businesses choose to utilize invoice factoring as one of their funding resources:
- You need fast cash to keep your operations running smoothly.
- You’re unable to receive financing from traditional institutions like banks or other lenders.
Most businesses that have chosen invoice factoring are dealing with one of these scenarios. By trading invoices for working capital, your business can keep running without any hitches. Companies that operate with a constant flux of invoices know how frustrating it can be to live on the edge, waiting for customer payments to secure the finance they need. Day-to-day operations are reliant on these payments, so when the outstanding invoice pile starts to add up, your company is probably lacking necessary funds because of it.
Other times, companies may be having a hard time finding traditional financing. When this is the case, invoice factoring can be the perfect option. The company with the outstanding invoices will receive the credit score inquiries and other qualifications pressures, instead of your business. This makes invoice factoring a useful type of financing available to businesses with poor credit or limited time in the industry.
Additional Reasons to Consider Invoice Factoring:
- Fast and easy
- Helps build business credit
- Detailed management receivable reports
- Leverage expertise of an invoice financing company or factor
- No debt to repay
- Enhance your purchasing power
- Small businesses are eligible
- Retain your equity
- Access to unlimited capital
- Aids in building business credit
- Accessible to nearly every industry
How Does Invoice Factoring Work?
Before we explore the cost of invoice factoring, let's discover how it works. In order to decide if it's worth the cost or not for your company, you'll need to know more about it. Once you have a thorough understanding of invoice factoring, you can make the best decision for your business. Choosing to work with a factoring company could be the answer to getting the cash you need.
Let's take a look at the invoice factoring process:
Step 1: Invoices Are Issued to Clients
The first step is all about the invoice. A statement is created to bill a client or customer based on an order, letting them know how much they owe with the invoice amount and when payment is due. These are called the "net" terms. The value of the invoice is important to note when you sell it to the finance company. The larger the invoice value, the more you can sell it for.
Step 2: Submit Invoices to Factoring Company
The next step is to send the outstanding invoice to the invoice factoring company for review and processing, all based on the terms of the invoice factoring agreement. Usually, this is done through an online management portal from the factor or through a designated email.
The factoring cost will depend on what has been agreed upon, including any discount rate, advance rate, or monthly minimum payment expected. The advance rate is the percentage amount of the collateral's value that a lender is willing to extend as a loan. Of course, the cost will also depend on the invoice value. Customers will know what fees to expect and how much they will have to pay when they make this agreement.
Step 3: Getting the Advance Payment
Factoring companies will then process and verify the invoices being sold to them, then give you the advance payment. Depending on your agreement, this lump sum is typically worth 80 to 90% of the invoice amount. This immediate cash is considered an advance payment, which you receive as the business owner of the invoice.
These advance payments are made by the Automated Clearing House (ACH) via direct deposit, straight to the business owner's bank account. If you need the money sooner than a day or two, the invoice factoring company may be able to send the payment through a wire transfer.
Step 4: Collecting the Invoice From the Client
The invoice factoring companies are then responsible for collecting the outstanding invoices that have been submitted. All invoices are payable within a certain period, but at some point, the client must make the payment to the factoring company based on the net terms the factor approved before the process began. When the client has paid the statement in full, the factoring company receives the money, and the invoice is settled.
Using the provided online portal, the business owner can see a schedule of accounts and accountability of all invoices being advanced. Smaller factors might email the "daily schedule of accounts" listing the invoices the business owner has sold to them, the amounts, and the due dates.
Step 5: Business Owner Receives the Remaining Funds From the Invoice
Once the invoice has been paid in full, the business owner will receive the remainder of the invoice proceeds, minus the invoice factoring fees set forth in the original agreement.
Breaking Down the Cost of Invoice Factoring
Now that you know more about invoice factoring and how it works, let's talk about the cost. Business owners have to make decisions that will benefit their company. Choosing a financing option that is unaffordable or a bad fit for your business could lead to financial issues down the line. Understanding exactly how much invoice factoring costs will help you make these crucial decisions.
To understand this type of financing, let's assume you are issuing a $20,000 invoice with 45-day terms. How would this example work? Continue reading to find out.
- The invoice financing company purchases the $20,000 invoice and gives you 90% of the face value as a deposit, giving you $18,000, the remaining $2,000 is held by the finance company, in reserve.
- Once the client pays the invoice in full, you will then pay the factoring company a finance fee of 2% for example ($400). This factoring cost is always apparent from the beginning of the process when the contract is made.
- You also receive the reserve back, in this example was $2,000.
- You’ve paid a total of $400 out of a $20,000 invoice for immediate payment of $18,000 and $2,000 reserve held until full payment from the invoice financing company.
- An additional monthly service fee is also common in invoice factoring ranging from $250-$500 depending on the volume and size of the agreement.
As you can see from this example, invoice factoring can be an affordable way to get the funds you need, fast. Plus, there are no surprise fees when you choose this type of financing. It all comes down to how your business operates and the totals of the invoices you're looking to sell. If you have cash flow problems, invoice factoring can be the way out.
Industries That Can Use Invoice Factoring
There are a wide variety of industries that utilize invoice factoring already. Any company with outstanding invoices or accounts receivable is eligible for this type of financing. AdvancePoint Capital has experience working with a wide variety of industries, including:
- Agricultural
- Manufacturing
- Medical
- Import/Export Companies
- Business Consultants
- Trucking and transportation
Any small business or large company can take advantage of this great financing alternative.
Common Questions About Invoice Factoring
a. How Many Invoices Can You Finance?
Some factoring companies may have limits on the number of invoices you can factor. It's essential to find a company that will work with your specific needs. We allow your business to factor as many invoices as you need, as long as your customer has a healthy financial history. Our deals generally range from $100,000 to $10 million, with terms extending from 120 to 150 days.
b. What’s the Difference Between Recourse Factoring and Non-Recourse Factoring?
In recourse factoring, the vendor bears the risk if the customer does not pay the invoice back. Alternatively, non-recourse means that the factor and not the vendor absorb the risk. So if customers go bankrupt or don't pay the invoice, for whatever reason, the factor has to pay the invoice. In this situation, the amount of risk the factor takes on will depend on how much of the invoice the customers are likely to pay. The factor is providing protection for a portion of the invoice. Both types of factoring take advantage of a factoring agreement to get paid.
c. If Invoice Factoring Isn’t for Me, What Are the Alternatives?
Not all small businesses have invoices to sell to get the financing they need. Thankfully, many lenders offer other funding resources for small businesses to take advantage of. From a short-term loan to financing through a business line of credit, there are endless opportunities to get the funding your company needs. Some lenders even offer a discount for women and minority-owned businesses.
Here are some alternative funding options:
- Business credit cards
- Short-term loan
- Long-term loan
- Business line of credit
- Equipment financing
- Merchant cash advance
- Small Business Administration loan
Moving Forward With Invoice Factoring: How to Apply
Since invoice factoring is such a unique form of financing, it's actually quite easy to apply for. As a business owner, you don't need to worry about financial checks or time in business because it's actually the person paying back the lender who is responsible for creditworthiness and other qualifications. The factoring invoice acts as collateral. To apply for invoice factoring and get approved, you must provide the following:
- One-page application
- List of names of businesses and contact info you are invoicing
- Accounts Receivable Ledger
- Actual invoices and their terms
Eligibility for invoice factoring is a lot more relaxed than other forms of alternative financing. If you need cash fast and have unpaid invoices, this could be the best option for your company.
Understanding the Cost of Invoice Factoring
To decide if invoice factoring is right for your company or not, you have to understand how it works, what resources are available, and what additional fees are associated with it. Any company with accounts receivable can utilize business factoring when their customers aren't paying their bills on time.
Small businesses and startups don't need to search hard for alternative financing when invoice factoring is available. Same with large companies dealing with customers who don't pay and the cash flow problems that follow. Get a free quote from AdvancePoint Capital today to get started on the invoice factoring process!
