You may have heard some fellow business owners talking about invoice factoring. It is also commonly shortened to just factoring. With this funding option, you sell your invoices or open accounts receivable to a third party for a reduced price. You get the cash up front. Think of it as being similar to collections but with a much lower loss ratio because the accounts are in good standing. According to Forbes, some companies offer up to 90 percent of the total invoice value. These are the main benefits of invoice factoring.
1. Improved Cash Flow
Most businesses have financial dry spells during a certain time of year. For example, a pool and spa business may have a dry spell during the winter months when people spend more time indoors. At such a time, there are also winter holidays that often result in more customers paying their bills late or at the last minute. If you are expecting to bring in $30,000 for the month but have to wait at least 30 days or more, any current expenses that you cannot afford would have to wait. Unfortunately, your vendors or landlord may want to charge hefty late fees if you have to wait that long to pay. With invoice factoring, you can get the money quick enough to pay your obligations without the late fees. Many businesses also use the extra cash flow for operating expenses, expanding inventory or paying for a large unexpected repair. As you make more money or grow your business, you qualify for more capital.
2. Fewer Collection Tasks
Collections is an inevitable process for every business that uses billing. With invoice factoring, the company that purchases the invoices takes on the responsibility of making and sending statements to collect money. However, factoring providers do not typically take on the entire risk of non-paying customers. According to CNN Money, the factoring company may eventually come after you for any unpaid balances. The good news is that the time saved by not having to send statements, conduct follow-ups and answer questions means more time to spend on high-yield tasks in your business.
3. No Credit Impact
Since factoring is closer to a purchase than a loan, you do not have to worry about your credit being affected by lender inquiries. Remember that the financial company offering factoring is more interested in the payment history of your customers since the provider is purchasing customer debt. Businesses that take out multiple loans or use revolving accounts for regular cash flow usually have poorer credit and a balance sheet that is riddled with debt. For this reason, financial advisors will tell you that invoice factoring is a better choice if you need money but want to keep your balance sheet clean. With factoring, you can still use credit cards and small loans responsibly to build credit but without the worry of making your debt-to-income ratio too high.
Small business owners especially like that a credit check is not the most crucial approval requirement for invoice factoring, which means quicker funding. If your business is newer or you do not have perfect credit, getting a traditional loan to cover day-to-day costs may be impossible. In the past, many small business owners used business cash advance loans for emergencies. Some still dip into their own personal savings instead. Both choices can create a big financial pit that is difficult to escape. Most factoring providers require you to have been in operation for at least six months to a year. You can factor some or all of your invoices depending on your needs. Since there is a fee for factoring and you only get a percentage of the invoice value, look at your balance sheet to see if you can improve your cash flow with more disciplined collection practices first.