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 through an invoice factoring solution, accelerating your access to working capital. If traditional banks have turned you down or you don't want to be tied up in bank loans, and your business utilizes customer invoices, invoice factoring services could prove to be a viable tool.
With invoice factoring providers and their financing services, there are some fees to be aware of. Usually, an invoice factoring contract includes processing fees and factoring fees. Examples of these additional finance fees are outlined in the contract. Whether your company needs money for taxes, making payroll, funding an upcoming project, or securing other resources, you can easily utilize invoice factoring.
For roughly 85-90% of the total statement amount, invoice factoring providers can get cash to businesses promptly. The remaining 15-10% is held in reserve by the invoice factoring company, which is an invoice factoring rate example. A portion will be returned to you, and the rest is subject to the fees mentioned above. These fees mainly depend on how long it takes the customer to pay and are calculated weekly, showcasing the nature of invoice factoring relationships.
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, offering financial flexibility to respond quickly to challenges and opportunities
- Helps build business credit and optimize profitability
- Detailed management receivable reports
- Leverage expertise of an invoice financing company or factor
- No debt to repay
- Enhance your purchasing power with more control over how your money is received and spent
- Retain your equity
- Access to unlimited capital as compared to traditional banks
- Aids in building business credit, an essential factor in future growth
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. In embracing invoice discounting, a statement is created to bill a client or customer based on an order. This then communicates how much they owe, along with the invoice amount and payment due date—these are known as the "net" terms. It's imperative to focus on the value of the invoice, which is a significant criterion when you sell it to the finance company. The larger the invoice value, the more you can secure through the sale. This process demonstrates how much your broker's credit history matters to the freight factoring firms, not your personal one—an interesting fact about invoice discounting.
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. This advance, typically worth 80 to 90% of the invoice amount, is provided with little regard to your customers' creditworthiness or likelihood of repayment, as the factoring company will assume responsibility for collecting the full repayment. 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. However, be aware there may be additional expenses like service fees, monthly minimum fees, and origination fees, among others.
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 under a default period that's payable, however, a customer default might occur and the client must make the payment to the factoring company within the agreed upon transaction terms. These terms were set and approved by the factor before the process began. Upon full payment of the statement by the client, the money is received by the factoring company, marking the conclusion of the transaction and that particular invoice is settled.
Utilizing the provided online portal, the business owner gains insight into all advanced invoices with a schedule of accounts and accountability. 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, making each transaction transparent and traceable. These invoices are normally involved in businesses that work with other businesses due to the presence of invoices in their transactions.
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 discount fee, known as the invoice factoring fees, set forth in the original agreement. Known as receivables factoring rates, these fees vary depending on the fee tier agreed upon with the factoring company.
How Much Does Invoice Factoring Cost?
Now that you know more about invoice factoring and how it works, let's talk about the cost. As a savvy business owner, you'll want to evaluate every financing rate that could impact your company. Choosing a financing option that is unaffordable or incompatible with your business could invite financial instability later. Thus, a firm grasp on the exact costs of invoice factoring will assist in these crucial decisions.
To decipher this type of financing, let's consider this scenario: You're issuing a $20,000 invoice with 45-day terms. So, how does this example function? Keep reading to find out.
- The invoice financing company purchases the $20,000 invoice and gives you 90% of the face value as a deposit, providing you $18,000. The remaining $2,000 is held by the finance company, as reserve.
- Once the client settles the invoice in full, you will compensate the factoring company with a financing rate of 2%, for illustration ($400). Remember, this factoring cost is transparent from the initiation of the process when the contract is drawn up.
- The reserve amount is rereleased to you, which in this example, turns out to be $2,000.
- Hence, you’ve shelled out 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.
- Be aware that an additional monthly service fee is also a common constituent in invoice factoring. This transaction fee typically ranges from $250-$500 depending on the volume and size of the agreement.
From this illustration, it's apparent that invoice factoring can be an affordable means to secure the funds you need, promptly. Plus, because businesses adopt the burden of non-payment themselves, rates are frequently lower with invoice financing. There are no hidden charges with this type of financing. Ultimately, it all boils down to how your business operates and the value of the invoices you're planning to sell. Should cash flow issues plague you, invoice factoring could well be your escape route.
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:
- 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
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.
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.
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. Origination of an account is simple and straightforward. As a business owner, you don't need to worry about financial checks or time in business because the likelihood of repayment isn't about your creditworthiness but about the customers--they are the ones 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 their 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 with the absence of additional fees that include service fees, monthly minimum fees, and origination fees among others.
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. Across a diverse array of sectors, from healthcare to construction, any company with accounts receivable can utilize business factoring when their customers aren't paying their bills on time. Factoring lenders often come in the form of direct lenders or fintech companies, which are a viable alternative to traditional banking.
Small businesses and startups in particular, don't need to search hard for alternative financing when invoice factoring is available. This is true even for large healthcare companies dealing with customers who don't pay and the resulting cash flow problems. Get a free quote from AdvancePoint Capital today to get started on the invoice factoring process!