Do You Need Invoice Factoring for Your Small Business?

Do You Need Invoice Factoring for Your Small Business?

Invoice Factoring

Do you own a small business? If you do, you are probably familiar with the delicate balancing act that is required to ensure there is enough cash flow in your business for payroll even when you have invoices that have not yet been paid by your customers. However, are you also aware of invoice factoring companies that have been created to help provide small business owners with much needed cash flow to keep their companies afloat?

You need to understand:

  • The concept of invoice factoring
  • The concept of invoice financing
  • Options for financing

Once you have this knowledge, you will be able to make the best financial decision for your business needs.

Invoice Factoring

In technical terms, invoice factoring is not considered a loan. The process actually involves business owners selling their invoices at a discounted price to a company that specializes in this niche. In exchange, the factoring company will give the business owner cash. In return, the factoring company will then own the invoices and collect the outstanding debt within 30 days to 90 days.  If you need help with debt recover and other services, check out HJS Recovery.

For example, you may own a small auto parts store. You sell some of your products to another business, and an invoice of $12,000 is created. Although your customer has agreed to pay the invoice off within 30 days, you need the cash to meet payroll the next week. What your business has is a shortfall of cash.

At this point, you have several options. You could apply for a traditional loan with a lender, however you would probably need excellent credit along with physical collateral. On the other hand, you may be approved for a loan, but the loan closing would be several weeks away.

Your other option would be to contact an invoice factoring company. They may agree to purchase the invoice for $11,640. This would equal the original amount of the invoice minus a factoring fee of 3%. The company may then decide to advance you 80% to 90% of the purchase price, and give you the remaining balance once the invoice has been paid.

Keep in mind that this is just an example, and factoring fees can range from 1% to 6%. The exact percentage will depend on:

  • The amount of the invoice
  • Your company’s volume of sales
  • The creditworthiness of your customer
  • If the contract is recourse or nonrecourse

Recourse and nonrecourse refers to who will be responsible if the customer does not pay the invoice, the factoring company or your business.

The Advantages and Disadvantages

With any type of financial transaction, there are pros and cons associated with it. One of the advantages is that your business will get the cash it needs for capital or to help fill in a gap that is created when you invoice slower paying clients.

Another advantage is that while your company’s cash flow is improving, you will still be able to honor the longer payment terms of your clients.

Small business owners who have credit issues or do not meet the qualifications of traditional lending find that approval for invoice factoring is much easier. These companies are only concerned with the creditworthiness of the clients and the value of the invoice.

Unfortunately, there are some disadvantages as well. The first thing that you will need to consider as a small business owner is the price of the service. Application fees, credit check fees, processing fees and late fees are all additional expenses that could result in you paying higher percentage rates.

You will also need to consider that if your customer has a bad credit rating, it could derail the entire process. Many factoring companies do verify this information before approving financing. If the customer has a history of making late payments or not making payments at all, you could be denied financing.

Financing and Factoring Options

It is important to know the difference between invoice financing and invoice factoring. Companies that offer invoice financing do not purchase your invoices. Your invoices can be used as collateral so you are able to get the funding you need. This money must be repaid, and you are still responsible for collecting on the invoices.

So, is invoice factoring or financing something that you would consider if you are short on cash? It is important to weigh the pros and cons, know the difference between the two and find a reputable company to work with that will help you get the cash your business needs during financial droughts.

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