What is Invoice Factoring?
Every company requires a steady flow of working capital. Startups and small businesses are especially vulnerable to the challenges that come with staying ahead of their expenses. When a company’s structure means they bill their clients for services or goods to be paid on a 30, 60, or 90-day cycle, there’s a delay in their cash flow, but operating expenses can’t wait for profits to come in.
Small businesses may struggle to get a bank loan, and the waiting time can defeat the benefits when a loan finally comes through.
Invoice factoring allows a business to focus on its success without a time gap growing with their operating expenses. It’s a loan on unpaid invoices, a type of business financing that’s often better than taking out a bank loan or a line of credit. Specifically, it’s a loan against unpaid customer invoices, providing immediate cash on hand for daily/monthly costs.
Another way to define invoice factoring is to say that a business is selling its accounts receivable in trade for upfront cash. They’re paid by the lender, and the lender then collects on customer invoices.
Invoice financing is a similar option for a business to consider. They may be advanced for the entire value of an invoice upfront, but they will have to make payments weekly over 3-6 months, where a business receives a smaller portion of the invoice in factoring, and the repayment can continue until the customer pays the invoice.
Invoice factoring fees typically come at a higher rate than a standard business loan, because they provide immediate cash at hand. Rates could be as much as 5% per month until they paid an invoice. They can negotiate rates in different ways, and may include an initial fee, maintenance fees, processing fees, and similar costs.
To approve a business, invoice factoring lenders will request documents like LLC certificates or a company’s articles of incorporation. They’ll look over a few years of tax records, financial statements, and research whether the company has any liens.
How Does Factoring Receivables Work?
When a company chooses invoice factoring as a form of business loan, they’re selling their outstanding invoices in trade for instant cash on hand. This is called factoring receivables. A business is selling invoiced customer payments owed in the next three months to cover their immediate expenditure. We can also understand this as the business borrowing against their accounts receivables.
When a lender calculates the risks associated with granting a loan, they consider all marketable securities, cash equivalents, and the value of outstanding invoices owed by customers.
Factoring receivables, also known as receivable financing, means a lender will typically pay a business upfront in one installment, typically for as much as 90% of the outstanding invoice. They pay the remaining percent minus the fees once they receive the customer’s invoice payment, where fees depend on the business’ creditworthiness.
There are two main types of invoice factoring loans: recourse factoring, where the liability of customer payments is on the borrower and non-recourse, placing the burden of risk and collections on the lender, where the trade-off means higher rates.
Sometimes, but not always, a business can choose which invoices they wish to borrow against. This practice is called spot factoring.
Is Invoice Factoring Right For Your Business?
Many businesses face a constant challenge covering payroll and other monthly expenses, even when they are thriving. Waiting for customer invoices to be paid can take as long as 90 days, but meanwhile, there are rental costs, insurance, worker salaries, and other expenses that won’t wait. Fortunately, small businesses have options, one of them being invoice factoring.
Invoice Factoring for Businesses
Is Invoice Factoring Right For You?
Take advantage of Invoice Factoring if your business relies heavily on customers who pay their invoices 30, 60, or 90 days after your associated costs, and you’re missing out on the opportunity to take on more clients to grow your business. This solution can be a more cost-effective alternative to a small business loan.
If a company doesn’t have the cash inflow to operate for three months while awaiting client payments, it might benefit from invoice factoring over a business loan. Invoice factoring should be about operating cash, where a business is in profit, but client payment delays prevent the company’s ability to scale.
When a business needs to cover on-hand operational costs more than the value of the customer invoice, and cash flow means more opportunity for growth, the cost of invoice factoring makes sense.
For most businesses looking to get an edge on the time gap between profits and operational costs, invoice factoring not only can help them stay afloat, but it allows them the flexibility to take on more business.
Most times, the benefits far outweigh the risks.
Merchant Cash Advance
A merchant cash advance is a business cash advance program that provides you with capital by purchasing your future credit/debit card sales.
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