Summary: Invoice factoring, an alternative source of business funding, is a popular way to finance small companies. It solves four key problems:
- It can improve your cash flow
- It can enable you to provide payment terms to your clients
- It provides a stable platform that can be used for growth
- It is available to small companies
However, not every company can benefit from factoring because it only helps companies that have a specific cash flow problem. This article helps you determine if factoring is right for you and how it can help your business. We cover the following:
- Is this you?
- Can a factoring company help you?
- Who uses a factoring company?
- How does factoring work?
- The two common types of factoring structures
1. Is this you?
Do you own a small company that works with larger companies that pay their invoices in up to 60 days? Offering 30- to 60-day terms is common in commercial transactions. Larger companies expect to get terms from their suppliers.
However, offering terms can create problems for some companies that don’t have adequate cash reserves. They may run out of funds to pay their expenses before their clients pay their invoices. It can also affect growing companies, as your expenses may get ahead of cash flow.
Most business owners try to solve this problem by juggling their expenses while they wait for invoice payments. They hope things will improve soon. This strategy may work for a short period. However, it may also allow the problems to escalate into a financial spiral.
2. Can a factoring company help?
Factoring companies can solve the root cause of this common cash flow problem. You need quick payment on your invoices so you can pay company expenses. However, your clients pay on 30- to 60-day terms.
The factoring company solves this problem by providing an advance on your slow-paying invoices. Factoring accelerates the receipt of revenues that were locked in slow-paying invoices. As a result, your cash flow improves, and you can pay your expenses. More importantly, you can start offering payment terms to clients with confidence.
It’s important to note that invoice factoring is not commonly considered a loan. Instead, the finance company buys your invoices that are due in 30 to 60 days and pays them immediately. This transaction is usually considered the sale of an asset. Consequently, the qualification requirements are simpler and the solution is available to small companies.
3. Who uses a factoring company?
Most factoring companies work with small to mid-sized businesses that sell to corporate or government clients. The most important requirements for this type of funding are:
- Having quality invoices
- Working with creditworthy clients
- Not having liens against your invoices
- Having 15% or higher profit margins
Factoring can improve your cash flow if your financial problems are caused by slow-paying customers and not by other reasons. This last point is important. Factoring doesn’t help much if your company is unprofitable or has other problems.
4. How do factoring companies structure transactions?
Most factoring companies structure transactions by financing your invoices in two installments. The first installment, called the advance, covers about 85% of the gross value of your invoice. This payment is provided shortly after you send the invoice for financing.
The second payment is provided when the client pays for the invoice. It covers the remaining 15%, less a transaction fee. This payment concludes the transaction, though most companies factor their invoices regularly.
The transaction terms vary based on your industry, the credit quality of your customers, invoice size, and other parameters. Industries such as trucking and staffing companies usually have higher advances and the lowest fees. Higher-risk industries, such as construction, usually have lower advances and higher fees.
To learn more, read “What is Factoring?” and “How Does Factoring Work?”
5. Transaction types
A factoring company can finance your invoices in two different ways: with or without recourse. In a recourse transaction, the factor can return the invoice to your company if it’s not paid within 90 days.
Non-recourse transactions are different. The factoring company cannot return invoices if your end customer does not pay them due to insolvency. These programs vary by factoring company and your contracts should outline the details.
Keep in mind that factoring programs don’t protect against payment disputes. Invoices that aren’t paid due to a dispute are charged back to clients regardless of recourse type. Lastly, a factoring company will not buy invoices that are payable by customers with a high chance of default. This practice allows factoring companies to limit their exposure to risky invoices. However, a non-recourse plan can protect you against unexpected bankruptcies.
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We can provide you with competitive factoring terms. For more information, get an online quote or call us toll-free at (877) 300 3258.