Invoice factoring can be an appealing way for businesses with outstanding accounts receivables to raise needed cash quickly. Factoring companies will purchase blocks of a business’s unpaid invoices, fronting between 85 and 90% of their total value. The business is then charged a fee every week until the last invoice is paid by the customer, at which point the factoring company will release the remaining 10 to 15%.
Invoice factoring frees up otherwise inaccessible cash. But is the process right for you? We’ll go over a few of the pros and cons to determine whether or not invoice factoring is a good fit.
Invoice Factoring Pros
There are excellent reasons for invoice factoring’s success. Here is a handful of the most compelling.
Get Fast Cash When You Need It
Unlike a standard loan, which can take weeks to months to process, businesses can convert their unpaid invoices to cash quickly, often within a day or two. Instead of having to wait 30, 60, or 90 days for your customers to satisfy their invoices per your terms, you can collect the money immediately.
Approval Is Relatively Easy
Your creditworthiness isn’t a factor when you apply for invoice factoring. That’s because it’s you’re customers that will be paying back the “loan” when they pay their invoices, not you. This feature makes factoring ideal for businesses with troubled credit histories. And because your invoices provide the collateral, you don’t need to worry about putting assets in jeopardy.
You Can Factor Repeatedly
You’re not limited to a single factoring transaction. As long as your customers remain in good standing and you keep invoices coming in, you can factor as often as you like. Many businesses establish a working relationship with a factoring company and regularly use the service to keep their cash flow healthy.
It Allows You to Offer Customers More Flexible Terms
Businesses that regularly encounter cash flow issues may not be able to extend their customers generous credit terms. With invoice factoring, you can convert invoices to cash immediately, which means you can extend the length of time your customers have to pay you without adversely affecting cash balances.
You Can Offload Invoice Collection Responsibilities
Factored invoices are collected by the factoring company, which means you don’t have to think about it. And if you enter into a non-recourse factoring arrangement, the factoring company assumes your customer’s credit risk. Non-recourse agreements charge a higher fee, but the benefits may be worth it.
Invoice Factoring Cons
As useful as invoice factoring can be, it isn’t perfect. Here are a few negatives to keep in mind.
It Can Be Expensive
Fees can range between 1 and 5% of the total invoice amounts, partially depending on how quickly your customers pay the factoring company. These fees are more than what you’d generally pay for a line of credit. However, the ease of approval often makes up for the added expense.
You’ll Still Be Responsible for Bad Debts
Unlike the non-recourse factoring arrangements mentioned earlier, recourse factoring doesn’t assume responsibility for collecting from clients who don’t pay. Suppose an invoice you sell to a factoring company isn’t paid. In that case, you’ll be responsible for either returning that money to the factoring company or submitting a new invoice of equal value. Factoring companies aren’t collection agencies.
You Won’t Qualify If Your Customers Don’t Pay
Your creditworthiness isn’t a significant concern when applying for factoring, but your customer’s creditworthiness is. A factoring company will ask to look at your customer’s payment histories, and if they regularly pay you late, you’ll be less likely to qualify for invoice factoring.
The Factoring Company Will Contact Your Customers
When you sell invoices to a factoring company, they’ll contact your customers to let them know where where to remit payment. They may also communicate with them if payments are late. If it makes you uncomfortable to have a third party company calling on your clients and having access to their financial information, factoring may not be for you.
You Can’t Collect on Invoices You Don’t Have
If sales are down, you might get a loan to help float the company until conditions improve. You can’t do that with invoice factoring, because low sales mean low invoice levels, and without invoices, you have nothing to factor.
Is Invoice Factoring Right For You?
Many small businesses can benefit from an invoice factoring relationship but like with every financing option, it depends on your unique situation. Make sure to weigh invoice factoring against all other options available to you and choose the one that makes the most fiscal sense.
There are some disadvantages of hiring an invoice factoring company too. They charge between 1 to 4 percent of the net invoice amount. You are no longer in complete control of your invoices now. Additionally, all past-due receivables must be handled separately because they do not perform debt collections. For your past-due accounts, you will need to involve a collection agency separately.