Invoice Factoring For Small Companies

Summary: Small business owners often have difficulties finding the right financing for their companies. This can leave them unable to take on growth opportunities. It also makes it harder to operate the business and handle challenges.

This article explains invoice factoring, a financing product that helps small companies improve their cash flow. It works by financing your accounts receivable. We cover the following:

  1. Do you have this problem?
  2. Improve cash flow without financing
  3. Small business invoice factoring
  4. Advantages
  5. Be careful of minimums
  6. Is factoring right for you?

1. Do you have this common cash flow problem?

Having commercial and government clients offers several advantages to small business owners. These clients can be a source of steady work and reliable revenues. However, they often demand 30- to 60-day payment terms.

Payment terms give your clients up to two months to pay their invoices. They are typical of large company contracts and are usually non negotiable. You must agree to them if you want your client’s business.

a) Payment terms and cash flow

This situation may create financial problems for some small companies. The small company must pay all the expenses of delivering their services or products. Once the project finishes, they must wait 30 to 60 to get paid. In the meantime, they must cover all business expenses from their emergency cash reserves.

Unfortunately, most small companies don’t have adequate cash reserves and can’t handle this situation well. They can easily get into financial problems if their expenses get ahead of their small reserves. Furthermore, these problems can put your company into a full financial tailspin if not handled correctly.

In the next section, we discuss how to improve your cash flow without using any financing. This strategy is usually the most cost-effective way to solve cash flow problems for any business. However, these solutions take time to deliver results.

2. Improve cash flow without financing

You can often improve your cash flow by following the right business practices. Many cash flow problems have solutions that don’t require financing. Instead, you can often fix these problems by simply improving your business processes.

In our experience, the cost of making these changes is comparatively small, while the results can be substantial.

a) Improve your invoicing and collections

Many small companies have cash flow problems simply because they don’t handle invoicing and collections correctly. However, invoicing and collections are two essential functions in the business and must be handled accordingly. Companies can address this problem by using the following strategy:

  • Check commercial credit on all clients
  • Use well-written contracts
  • Verify the client is happy with the product or service
  • Send invoices promptly
  • Follow up regularly

b) Discounts for early payments

Improving collections helps ensure that clients pay their invoices on time. However, you may need clients to pay in a few days rather than a few weeks. One strategy is to offer these clients an early payment discount in exchange for a quick payment.

Most companies offer their clients a 2% discount if they pay in 10 days or less. Otherwise, the client has to pay in their usual 30 to 60 days. Although offering a 2% discount is common, it is not a rule. Some companies negotiate better terms with their clients and offer a lower discount.

c) Work only with clients who pay quickly

Another somewhat extreme strategy is to restrict your client base to companies that pay their invoices in a few days. This strategy is challenging to execute if you are in a competitive environment. However, it may work if your product or service is unique enough.

Always check your client’s business credit before pursuing this strategy. Commercial credit checks help ensure that you work only with reliable clients.

3. Small business invoice factoring

The strategies in the previous section can improve your cash flow effectively. However, these strategies have some limitations and take time to implement.

Companies that need reliable or immediate financing should consider using small business factoring. Factoring enables small companies to finance their invoices. It improves cash flow quickly and provides working capital to cover business expenses.

Factoring plans have simple qualification criteria and can be deployed quickly. This makes them an ideal option for small companies that need to improve their cash flow but can’t qualify for traditional financing.

Read “What is factoring?” to learn more.

a) How does factoring work?

Factoring improves your cash flow by financing your open invoices. It bridges the financial gap between delivery of services and payment, providing funds to pay expenses.

Most invoices are financed in two installments. However, trucking owner-operators and staffing companies qualify for a single installment transaction with higher advances.

The first installment usually covers about 85% of the invoice. It is deposited into your bank account shortly after processing. Once your customer pays the invoice, the factoring company deposits the remaining 15%, less the factoring fee. The second installment settles the transaction.

Most small companies that deploy a factoring line use it regularly. This provides ongoing working capital, providing funds to cover expenses and take on new opportunities.

Read “How does invoice factoring work?” to learn more.

4. Advantages for small companies

Factoring lines have a number of advantages and few disadvantages. These are the most important advantages.

a) Improve cash flow quickly

The most important advantage for small businesses is that invoice factoring can improve your cash flow quickly. It’s an attractive alternative for companies that need immediate working capital.

b) Adapts to growing companies

Most conventional solutions like loans and lines of credit have pre-set limits. Increasing the limit requires going through the lender’s underwriting process. Invoice factoring lines are different and have flexible limits. They can adapt to growing revenues as long as the invoices meet the financing criteria.

c) Enables you to offer net 30 terms

A factoring line enables you to offer net-30 terms to clients while minimizing cash flow problems. It provides a stable platform for growth.

d) Simple qualification

Factoring is designed to help small businesses that are unable to obtain conventional financing. Consequently, the solution has relatively simple qualification requirements. Your company must:

  • Be properly incorporated
  • Have quality invoices
  • Have profit margins over 15%
  • Not have liens/tax issues

5. Be careful of factoring minimums

Some factoring plans have minimum volume requirements, while others don’t. In a factoring plan with minimums, you agree to finance a minimum invoice volume every quarter. In exchange, the factoring company provides you with a lower price.

Factoring companies can charge you a minimum fee if your volume goes below the pre-determined limit. Consequently, these plans must be used only after careful consideration.

Companies with uneven revenues and self-employed professionals will usually be better off with a plan that has no minimums. Otherwise, they risk paying the minimum fee, which can be expensive.

Companies with stable or growing revenues may consider a plan with minimums. This will get them a better rate, which decreases the cost of financing and increases profit margins. However, agree to minimums that you are certain you will meet. Provide your company with a wide margin of error so that you won’t trigger minimums should your revenues decrease unexpectedly.

6. Is factoring right for your company?

Every small faces a unique set of challenges and opportunities. Consequently, there is not a single answer that applies to every situation. There are some general rules of thumb you can consider. Factoring will usually benefit your company if your:

  • Cash flow problems are due to slow-paying clients
  • Clients pay in less than 60 days
  • Profit margins are above 15%

Consult with your CPA or your finance team if you are unsure if factoring is right for you.

Get a factoring quote

We are a leading provider of small business factoring and can provide you with competitive terms. For more information, get a factoring quote or call us toll-free at (877) 300 3258.