Small business owners are often challenged when a large customer requests 30 to 90 days of credit to pay an invoice. As a business owner, you want to offer credit terms because it improves your ability to sell to large clients. However, offering credit terms can also hurt your company if you don’t have financial reserves and cannot wait four to eight weeks to get paid.
The cash flow dilemma
These conflicting payment interests pose a dilemma for business owners. You must take clients on credit to grow your business. But taking clients on credit can create financial problems. This is a risky way to grow a business. The decision to offer credit terms is not easy, especially for small companies without financial reserves.
There is, however, a way to offer credit terms without risking your cash flow. You can finance your net-30 to net 60 term accounts receivable by selling them to a company that specializes in invoice financing.
Why would a company sell its accounts receivable?
Few small business owners are aware that they can sell their invoices to improve their cash flow. However, receivables financing is a well-known solution among larger companies. Larger companies use this option because it reduces the time between providing a service (or product) and getting paid. This strategy improves their cash flow, enabling them to meet corporate expenses.
Invoice financing lines have many advantages and few disadvantages. Most lines are flexible and can grow as your sales grow. They are also easier to get than business loans. These features make invoice financing an attractive option for small companies with great potential but without a lot of tangible assets.
How does invoice financing work?
The process of selling receivables to improve cash flow is known as factoring. It is simple to use and requires only a couple of days for the initial setup. Once the account is set up, your company can factor invoices as needed.
1. Find a factoring company
This type of financing is commonly offered by factoring companies, which specialize in offering this solution. Some banks have internal factoring divisions; however, they often work with larger clients only. Most factoring companies are small to midsize businesses.
Note: If you are evaluating finance companies, read our article on “How to find the best factoring company for your business.”
2. Negotiate a contract
Once you have selected a company, you need to negotiate a financing contract with them. The contract stipulates essential details such as the rate, advance, minimums (if any), and term length. The term length of contracts varies by provider and transaction details. Some factors offer short-term contracts that can be terminated at any time. Others factoring companies require you stay with them for a determined period of time. Ultimately, you get what you negotiate.
Note: It’s important that you understand the contract well. Consider getting legal advice if you require it.
3. Select invoices that need funding
Once a contract is in place, you can select the clients whose invoices you want financed. Then, the factoring company evaluates your client’s credit and determines if the invoices can be funded. Most factoring companies buy invoices from creditworthy commercial clients who pay in 30 to 90 days.
4. Send out the notices of assignment
Once the credits are approved, the factor sends a Notice of Assignment (NOA) to each of your selected customers. Sending a NOA is a standard process among all factoring companies.
5. Finance the invoices
Once the account is set up, you can use it as often as required. Most invoice sales to a factor are financed in two installments.
You get the first installment, usually 85% of the invoice, when you submit the invoice to the factoring company. You get the remaining 15%, less the factoring fee, once your customer pays the invoice in full.
The first installment is often called the “advance.” Advances average 85%; however, they can range from 70% to 95% based on your industry, volume, and other details of the transaction.
Can I sell any of my invoices?
Factoring companies do not buy delinquent invoices or invoices that are at risk of not getting paid. Those types of invoices are best handled by using collection companies or attorneys. Instead, factors buy invoices from customers that will pay – but will take 30 to 90 days to pay. Factoring is considered a tool to improve cash flow, not a tool to manage troubled invoices.
Factors evaluate the commercial creditworthiness of the invoices you want to sell, which helps determine their quality. They also review the contract terms of the invoice to determine when it’s payable and if there are any potential issues.
Additionally, any invoices you sell to a factor must be unencumbered by UCC liens and similar instruments. These encumbrances usually originate from loans, equipment financing, past-due taxes, and judgements.
How much does financing invoices cost?
The cost of factoring your receivables varies based on the volume of invoices, their creditworthiness, and your industry. In general, typical 30-day rates range from 1.15% to 3.5%. Note that fees are usually prorated.
Keep in mind that the true cost of factoring involves more than just the discount fee. To compare factoring proposals, you must take both the advance and the rate into consideration to determine the cost-per-dollar.
How quickly can I get funded?
Most clients can get their first batch of invoices funded shortly after their account is set up. The first funding may take a couple of days. However, subsequent invoices can usually be funded on the same day, as long as they are submitted early and can be verified quickly.
Get a factoring quote
Are you looking to sell your invoices to a factoring company? We can provide you with high advances at low rates. For more information, get an instant quote or call (877) 300 3258.