For many businesses, invoice factoring seems like a godsend. Instead of waiting weeks or months for idle clients to make the payments they owe, businesses can collect their accounts receivable through a third-party factoring company that purchases unpaid invoices with only minor discounts and fees. By factoring, a business can avoid the headache of waiting on clients that may not always pay in a timely manner. It’s a fast, pain-free way to improve cash flow and decrease risk, which to any business feels like a divine miracle.
However, invoice factoring isn’t for every business. Before you bank on the opportunity to sell your invoices to the first factoring company you meet, you should learn the right and wrong ways to use factoring to keep your business functioning properly.
Requirements of Factoring
Unfortunately, not every business has this fast, easy funding opportunity available to them. Perhaps obviously, only businesses that rely on invoices for income are able to factor their invoices. Often, factoring companies limit potential applicants further, so that only businesses with commercial or government clients ― i.e. B2Bs ― can participate in factoring programs. Further, those commercial or government clients must be established, with some history of success and creditworthiness. Unfortunately, retail businesses are usually unable to sell their invoices.
Additionally, invoice terms must be specific for factoring companies to consider purchasing them. Companies vary on what terms they will accept, but it is safest to impose 30- to 90-day payment periods. Finally, businesses that have histories of legal or financial troubles are often rejected by factoring companies. Just as you do not want to accept a client with questionable character, factoring companies tend to avoid doing business with businesses that pose them unnecessary risk.
Factoring does require a few nominal fees; if factoring companies paid you the full amount due from your invoices, they wouldn’t be in business for long. Typically, factoring companies will charge between 3 and 5 percent of your invoices’ value, so if your invoices are worth $1000, the factoring company will give you between $970 and $950 for them. Some factoring companies charge additional rates, some of which are exceedingly confusing ― which is why it is important to work only with a factoring company you trust.
Trustworthy Factoring Companies
It is imperative you perform research on your factoring options before selling your invoices, so you don’t end up doing business with a firm that is either deceptive or tacks a bunch of additional fees to every factored invoice.
As you should do with any potential business partner, you should evaluate potential factoring companies for reliability and reasonability. In your initial research, you should strive to find a firm’s factoring options ― for example, whether they allow spot factoring, which gives you control over which invoices to sell, or contract factoring, which requires a minimum monthly volume of invoices. Additionally, you should be able to learn the level of professionalism of various firms based on their online assets; a well-designed website containing useful, upfront information indicates a company that will treat you and your clients with respect.
Few factoring firms publish their rates online, but they should be forthcoming with their rates in a phone call. As mentioned above, all factoring companies will claim a percentage of the value of your invoices. However, some might also charge you interest for unpaid invoices, and that rate could increase the longer the invoices go unpaid. It is important, then, that you understand your company’s pricing structure before you give your invoices away, or you might pay more than you would have made even without factoring.
Correct Use of Factoring Funds
Unlike loans, cash advances, or other funding ― for which you should have a clear plan so you can pay off your debts quickly ― funds acquired through factoring are essentially indistinguishable from regular income. Therefore, you should use your factoring cash the way you would normally. Ideally, you will use the majority of your income to pay employees, repair equipment, replenish supplies, and otherwise maintain your business operations. If factoring provides you with enough extra cash, you might consider devoting that money to business expansion, adding products or services, acquiring new locations, or otherwise entering new, untapped markets to encourage business success.