What are the benefits of invoice factoring?
If you are a small business owner, you can easily turn unpaid invoices into working capital. Rather than waiting for weeks or even months to receive payment from customers, you can get cash advance by selling customers’ invoices at a discount. This can be the best option for business owners who do not receive immediate payment from their customers and need funds to manage the daily business operations. The best part of it is that you will be accessing funds that you have already earned, and you don’t have to worry about any future debts. Invoice factoring is also referred to as accounts receivable financing or invoice financing. Invoice factoring is meant to solve short term financial problems. The funds can be used to cover payrolls, repair equipment, pay suppliers and other day to day expenses.
How invoice factoring works
Small business owners can at times be at a fix. There is a new client who wants to do business with you, but there are some customers who have yet to pay their invoices and you do not have enough funds to take up new orders, which forces you to say no. But this problem can easily be solved by invoice factoring.
Invoice factoring usually involves three parties:
- The business that issued the invoice
- The debtor
- The financing company
Here is a good example of how invoice factoring works:
For instance, you run a furniture store and sell goods to a customer, creating a $10,000 invoice. The customer promises to pay the money within 90 days. But you may still need cash to pay your employees at the end of the month. This means that you will be short of cash. You can still have the option of taking out a loan in a traditional bank. But chances are that you will be required to issue collateral, which will be sold if you default. Even if you qualify, you may have to wait for weeks for the loan to be processed.
Another option is to sell the invoice to the financing company and receive an advance in return. This advance is usually between 70% and 90% the value of invoices. Once the invoice is paid, the financing company forwards the remaining percentage less the fees. In the end, all the parties involved will benefit – the business gets an advance, the customer has ample time to pay off the invoice and the financing company, also referred to as the factor, collets a fee. The fee or discount rate can range from 1% to 5% depending on your sales volume, invoice amount and the creditworthiness of the customer. With invoice factoring, the financing company collects the invoice payments that they are financing. The factor here will directly approach customers for invoice payment. This is different from invoice financing in which it is the business that is responsible for the customer’s payment.
4 best invoice factoring companies 2018
- Paragon Financial Group
Paragon Financial Group is among the best invoice factoring companies known to help businesses get out of tough financial situations caused by slow paying clients. The company factors invoices ranging from $25,000 to $10M per month with a factoring rate of between 1.25% and 2%. Borrowers are also charged a one-time origination fee. Paragon Financial Group offers an advance rate of 80%-90% of the invoice amount which is deposited into your bank account within 24 hours. The company focuses more on the customer’s creditworthiness than your business credit. They also work with different industries including wholesaling, manufacturing and distribution.
BlueVine offers financing for invoices worth $50,000-$5M per month. One benefit of choosing BlueVine is that it can take only up to 10 minutes to be approved and receive the funds within 24 hours. Unlike other factoring companies, BlueVine does not directly interact with customers. The company charges a factoring rate of 0.25% of the invoice amount per week. The loan does not attract any maintenance or origination fee. You will however be charged a wire fee of $15. BlueVine offers 85%-90% of the invoice value as the advance rate. To qualify, you should have a credit score of more than 530, and be in business for more than 3 months.
- Harper Partners
Just like other factoring companies, Harper Partners work with businesses to improve their cash flow. Customers are allowed to choose between recourse and non recourse factoring. The company offers an advance rate of 90% with the factoring amount ranging from $25,000 to 5M. The discount rate is between 1% and 3% per month. You can still qualify for invoice factoring if you have poor credit or if you are still new in business. The company will only be in contact with your customers if you allow them to do so.
- TCI Business Capital
With TCI Business Capital, contracts are offered on a monthly basis and the discounts re-evaluated to see if you qualify for a reduction. If your customers pay on time, the factoring rate could be reduced. There are several factors that determine the rate, but the main ones include the amount you want to factor and the time taken for customers to pay. The discount rate ranges from 1%-4% per month with a factoring amount of $50,000-$20M. The company offers an advance rate of 90% of the invoice value.
When does invoice factoring makes sense?
If you need instant cash to cater for your business operations, invoice factoring is worth considering. First, it has a simple and straightforward application process, and secondly, the approved rates are higher compared to those in traditional lending institutions.
Tips for finding the best factoring company
Having being around for decades, invoice factoring is an established industry. But many small business owners are still not familiar with factoring services. There are also big changes in the industry, mainly due to the emergence of online invoice factoring companies. Here are the important things to look for in a good invoice factoring company.
- Transparency in rates and fees
When it comes to invoice factoring, transparency is very essential. You should ensure that the company has clear rates and fees. This can be done by asking lots of questions and doing background research. Most invoice factoring companies tend to advertise low factoring rates, but once you access their services, you may be hit by other undisclosed fees. The monthly factoring rate may also be low, but if the invoice is paid late, you can find yourself paying for the whole month.
There are also companies that have hidden penalties, and this is why you should not hesitate to read the fine prints. Most of these penalties are out of proportion, and you can easily avoid them by finding a better option.
Some traditional factoring companies are known to lock small business owners into long term contracts. To some extent, this may be a good deal, but it is also important that you ask questions and read the fine print. If it is a long-term contract, ensure that it will positively affect your cash flow.
- Time to get funding
If you are depending on the funds to buy equipment that is essential for the business or to make payrolls, the time taken for funding will be more important than anything else. In this case, you should ensure that the factoring company provides funding within 1-3 business days.
- Industry familiarity
The type of industry you are in will have an impact on the factoring terms and costs involved. Some factoring companies only provide loans to specific industries. You therefore should do your research and only work with a company that understands your industry needs and norms.
What is the difference between invoice factoring and a bank loan?
With invoice factoring, the accounts receivables are sold and not issued as collateral for the loan. The result is that the receivables are converted into immediate cash rather than waiting for several months for your customers to pay. The collection cost, time and efforts are placed in the hands of the funding company, and this will give you time to work on the crucial aspects of your business. The good thing with invoice factoring is that you will be able to receive funds for your business when you need it, and you can easily manage your business without any financial constraints. Invoice factoring can come in handy for companies that need quick funding and for some reasons, they are not able to access a loan from conventional bank loan. Before purchasing their invoices, invoice factoring companies will research your customers’ credit history to ensure that the business has a history of paying bills
How to qualify for invoice factoring
The qualifications for invoice factoring are much easier compared to other long term financial options. Credit scores, business profitability and annual revenues are some of the things that lenders look for in long term financing, but this is not the case with invoice factoring. The main things that most factors consider include the account receivables, article or organization or incorporation and the most recent tax returns. Some factoring companies may also consider the time you have been in business and a minimum credit score.
Benefits of invoice factoring
- Fast cash
With account receivable factoring, you will get immediate business capital to cater for short-term financial solutions.
- Easier approval
For businesses that may not be able to get business financing from other sources, invoice factoring can be a great solution. You also do not have to worry about poor credit, lack of collateral or limited operating history. The factoring company only cares about the value of your invoices and your customers’ creditworthiness.
- Immediate cash flow
Business loans can take weeks, or even months to be approved. But with invoice factoring, you can access cash quickly to ensure smooth running of your business.
- Customer relationships
Debt collection is among the most frustrating responsibilities for a business owner. Invoice factoring enables you to hand over such tasks to the factoring company. This makes debt collection easier. Since you won’t be the one to collect the debt, you will also have a positive relationship with your customers.
Factoring financing can look more complicated than securing a loan in a financial institution. But with factoring, you can borrow money against unpaid invoices to help meet your immediate business needs. The cost of factoring is also affordable, provided your clients make timely payments. If your customers pay invoices on time, there is no doubt that your business will benefit from invoice factoring.
Joshua is a financial lawyer who plans on writing a book about his experience on debt collection laws and lending terms and conditions. He is currently one of the senior partners at his law firm but wants to take more time off for his writing.
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