Factoring invoices has been gaining popularity as a way to finance companies that have cash flow problems due to slow-paying commercial clients. Factoring works by providing an advance on these invoices. This advance provides cash flow to operate the business and grow. To learn more details about factoring, read “What is invoice factoring?” You can also learn more about the solution and our programs.
Like any financing solution, factoring is not perfect. It has its pros and cons. This article covers the most important advantages and disadvantages of using invoice factoring.
Pros | Advantages
Factoring your invoices offers a number of advantages for your business. The nine most important benefits of factoring are:
1. It provides you with immediate cash
The most important benefit of factoring is that it provides your company with immediate cash. This funding should help fix your cash flow and give you resources to pay your expenses and take on new clients.
2. It lets you provide payment terms to clients
Most large commercial and government clients insist on paying invoices on 30-day to 60-day terms. If you cannot offer payment terms, your chances of landing these companies as clients are minimal. Factoring enables you to offer payment terms to your clients because you can finance your invoices shortly after creating them (as long as the goods/work has been delivered). Therefore, you can offer terms without the negative financial consequences.
3. It helps you manage the credit of your customers better
One of the major challenges of offering payment terms is trying to determine the creditworthiness of your commercial clients. Most factoring plans include customer credit reviews as part of their solution. This feature allows you to outsource this important task to experts.
4. It is relatively easy to get
Invoice factoring is easier to get than most solutions. The primary requirement is that you have invoices for delivered work that are payable by creditworthy customers. Aside from that, your business must be free of liens/encumbrances and legal problems.
5. The line can increase as you need it
Lines are tied to your invoice balance. Therefore, they can easily increase as long as your invoices increase and the credit quality of your clients remains good. This feature makes invoice factoring an ideal solution for companies experiencing an aggressive growth stage and needing financing that can keep up with the level of growth.
6. It can be a short-term solution
Factoring can be used as a short-term solution if you forecast that your current cash flow problems are temporary. Most factoring companies are happy to structure a 6-month plan to help you through your cash flow problems.
7. It uses your invoices as collateral
Most conventional solutions, such as lines of credit and loans, require substantial assets as collateral. These assets can include real estate, inventory, equipment, and so on. Factoring is different. It requires only your invoices (accounts receivable) as collateral.
8. It does not require you give up equity
One important advantage of invoice factoring is that it does not require you to give up any equity. This advantage is important because when you give up equity, you also surrender not only a portion of your company but also some of your control in the business. Furthermore, selling equity during financial distress to meet a cash flow crunch may not get you the best price for it.
With factoring, the relationship is purely time-based. And once the contract is done (unless it renews), everything finishes. You never have to give up any equity in exchange for funding.
9. It can be used by small businesses
Another important advantage of factoring is that it can be used by truly small businesses – even those making as little as $20,000 a month. Trying to get a regular business loan or line of credit for those amounts is nearly impossible, since many lenders rely on volume to make their profits.
Cons | Disadvantages
Although factoring is a great solution, it is not perfect. No solution is. Here are some disadvantages of factoring:
1. It costs more than a line of credit
Factoring usually costs more than bank offered financial solutions. Typical rates can range from 1% per 30 days to 4% per 30 days. Note that the rate and the advance are used in conjunction to determine your real rate. Learn more about the “True cost of factoring“.
2. It solves only one problem
Although loans and lines of credit can often be used for a number of things, factoring solves only one problem: cash flow shortfalls due to slow-paying clients. Therefore, it can be one-dimensional and should be used only to solve that problem.
3. It is labor intensive
Factoring can be labor intensive for the client. Every time you want an advance, you must submit a schedule of accounts, along with a copy of your invoices and any backup documentation. This task can often be done by email or through the internet.
4. Finance companies contact your customers
The factoring company contacts your clients at the start of the relationship and sends them a standard letter informing them that they are managing your invoices. The factoring company may also contact your clients if payments are late or if any major issues arise.
5. Finance companies don’t handle bad debt
While factoring companies are good at limiting bad debt, there is still a chance that some invoices will not get paid. Factoring companies are not collection agencies and do not behave like collection agencies. This point is very important. Bad debt will go back to your company so you can assign it to an attorney or a collections company.
How to select a factoring company
Lastly, factoring companies have specialties. It is important that you select the best factoring company for your specific situation. Questions to ask your potential factoring partner include:
- How long have you been in business?
- What industries do you work with?
- What are your usual terms and rates?
- Can you provide a list of references? (usually when a proposal is issued)
- How quickly does it take to set up an account?
Get a factoring quote
We can provide factoring lines with high advances at low rates. For more information, get an online factoring quote or call (877) 300 3258.