Invoice Factoring Basics: How To Pick A Factoring Company

Invoice Factoring Basics: How To Pick A Factoring Company

invoice factoring basics

If you’re a small business that sells products or services to other businesses, you’ve probably struggled with waiting for a customer to pay an invoice.

If you’re fortunate, the wait may be just for a few days. But sometimes, it’s 30, 60, 90 or more days.

It can be frustrating at times. You’ve done the work or sold the product, but now, you have to wait a while to record that revenue.

You end up wrestling with lumpy cash flow and long payment cycles that sometimes make it difficult to deal with everyday or emergency funding needs. Some customers, such as big corporations or government agencies, even demand generous payment terms or are simply slow payers.

For B2B businesses, or businesses that sell products or services to other businesses or organizations, there’s smart financing option to help you deal with extended payment cycles: invoice factoring.

Invoice factoring allows you to turn invoices into working capital. Instead of waiting 30, 60, 90 days or longer, you’re able to get a cash advance on an unpaid invoice, allowing you to use the funds for a pressing business need.

Here’s the best part: you’re accessing funds that you’ve already earned and not incurring any debt.

What is Invoice Factoring?

Invoice factoring is also referred to as “invoice financing,” “accounts receivable financing” and “receivable financing. In this financing arrangement, a business essentially sells its accounts receivables to a factoring company in order to gain quicker access to those funds. Instead of waiting days or weeks for the invoice to get paid, the business gets an advance on those funds faster, which means having the cash for urgent business needs. A small business owner can use the funds for day-to-day expenses, to cover payroll, purchase supplies, repair a piece of equipment.

Those funds could even make it possible for you take on an unexpected business opportunity. Many small business owners find themselves in this dilemma: a new potential client would like to do business with them, but they need to say no, because they’re still waiting for existing customers to pay their invoices and they simply don’t have the funds to accept a new order. That’s no longer a problem with invoice factoring.

How Invoice Factoring Works

There are usually three parties involved in an invoice financing transaction:

  • the business that issued the invoice
  • their customer, or account debtor, who owes payment on an invoice
  • the financing company, also known as the “factor,” that would offer the advance on the unpaid invoice

So here’s how it works.

After a company delivers the product or service to their customer, they issue an invoice. The company then “sells” the invoice to the factor. In return receives an advance, typically between 70% to 95% of the value of the invoice.

After the debtor pays the outstanding invoice, the business receives a “rebate” for the remainder of the funds, minus a fee that is based on the term and value of the invoice. In the end all three parties benefit: the customer gets cash upfront, their customer gets favorable payment terms, and the financier collects a fee.

When factoring makes sense

If you’re looking for faster access to capital, factoring is definitely worth considering. The application process is typically simple and straightforward. And the approval rates are much higher compared with a bank.

The application process typically does not include some of the major hurdles a small business encounters when applying for a bank loan. In fact, many small businesses typically qualify even if they’ve been declined by banks.

Most important of all, you gain access to funding faster allowing you quickly address pressing or long-term business needs.

When factoring may not be your best option

Factoring may not be for your small business if cost is one of your major concerns. Applying for a bank line of credit may be more tedious and take a longer time, but a bank line of credit is typically less expensive than factoring.

With factoring, the factor may also need to notify your customers about the financing arrangement, that their payments will need to be processed through through the factor. This could make some small business owners and their customers uncomfortable. Some small businesses worry about how this arrangement could affect their relationships with their own customers.

In traditional factoring, the factors even effectively take over your invoice financing system. Fortunately, that’s not the case with new online factoring services, which offer more flexible options. More on that later.

Tips For Choosing a Factoring Company

Factoring has been around for centuries and it is an established industry in the United States where it caters to specific industries. It is widely used in different industries and markets, such as public relations, professional services, marketing, technology, staffing,  wholesale trade and manufacturing companies.

However, many small businesses are unfamiliar with factoring. And the industry itself has been undergoing big changes, especially with the emergence of online, technology-enabled invoice factoring companies.

Here are key points to remember when shopping for a factoring company.

1. Transparency in rates and fees is important

Transparency is key in invoice factoring. Make sure the fees and rates are clear. Do your homework and ask lots of questions. Many invoice factoring companies advertise incredibly low factoring rates, but you could get hit by a series of undisclosed fees once you start using the service.

You may be charged a low monthly factoring rate. But if an invoice is paid even a day late, you may end up paying for that entire month.

Some traditional factoring companies also require monthly minimums. That means you would need to submit a minimum number of invoices for factoring, even if you don’t need the funds for your business. You can check out our guide to factoring contracts  to make you better prepared.

2. Watch out for those penalties

Some invoice financing companies have hidden penalties, so it’s important to read the fine print and ask a lot of questions in your quest for a factoring company. Some of these penalties are unfair or out of proportion in which case it’s smart to walk away.

3. Don’t get trapped in contracts

Many traditional factoring companies will try to lock you into long-term contracts. This may be a good deal for you small business if based on terms that clearly would allow you to save on financing costs. But just like any financing contract, read the fine print and ask questions. Make sure you wouldn’t end up with a long-term contract that would hurt, not help, your cash flow. In some cases, these contracts feature exorbitant cancellation fees. Others require you to submit a minimum number invoices for factoring, which mean you’re paying for financing that you don’t really need.

4. Understand what ‘notification’ means

Most factoring companies operate on a notification basis, which means they notify your customers when you sell your invoices, and also require the funds be routed to an account in the factoring company’s name instead of yours. This could be an issue in the beginning of a relationship with a factoring company. You need to  understand clearly how this financing arrangement is being communicated to your customers. It may be a good idea to be part of that process. Typically, this becomes less of an issue once you’ve started factoring invoices, and your customers become accustomed to how payments are processed.

5. Understand what ‘advance rate’ means

Here’s one term you need to know as you’re shopping for a factoring company: “advance” rate. That’s percentage of the invoice face value that you’ll receive upfront. A fair advance rate is 70% to 95% of the face value of the invoice. So for example, if your customer owes you $1,000, you should expect to receive an advance payment of $900 to $700 to your account.

6. Factoring Minimums vs. Spot Factoring

Again, remember that some factoring companies will want you to commit to factoring a minimum number of invoices as part of the contract. Some would even require businesses to submit all of their invoices from particular customers to the factoring company. This is known as “whole ledger factoring.”

But there’s different system that gives you more flexibility: “spot factoring” or “single invoice discounting.” This is system lets you decide which invoice to submit for an advance. Now, there may be a cost premium with “spot factoring,” but then you gain more flexibility in managing your invoices. If business is doing well, and there’s no need to submit an invoice to get funds faster, then you don’t have to do it.

The BlueVine Option

BlueVine is one of the pioneers of online invoice factoring. Launched in 2013, BlueVine offers flexible invoice factoring services, with credit lines of up to $5 million. You can get approved in as fast as 24 hours, and can receive funds with in a day on invoices due in 7 to 10 days.

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