Invoice factoring is a business financing solution popular with small and midsize companies. This article helps you determine if factoring is the right solution for your business. We guide you through eight questions to ask before considering a factoring facility.
1. Can my cash flow problem be fixed using factoring?
The first question to ask is if invoice factoring is the best solution for the type of cash flow problem your company is facing. Factoring helps companies that need funds sooner than the 30 to 60 days it takes their customers to pay. You can use factoring to pay operational expenses (such as payroll, rent, and suppliers) when you can’t wait until you get paid by your customers. Unfortunately, factoring doesn’t help if your cash flow problems are caused by something different. To learn more, read “What is Factoring?”
2. Do my customers have good business credit?
Factoring works differently from the way that conventional financing works. It allows you to sell your invoices to a factoring company and get an immediate payment. However, factoring companies buy your invoices only if your customers have good business credit. They typically check your customer’s business credit using a credit bureau, such as Dun and Bradstreet. A factoring company won’t be able to buy invoices that have collections problems or don’t meet their funding criteria. These invoices are best handled by a collections firm or an attorney.
3. Do your customers pay in less than 90 days?
Factoring works best for invoices that are payable in 15 to 60 days. It can work for invoices that take longer to pay as long as they don’t exceed 90 days. Invoices that take 90 days or more to pay are not eligible for factorable. This restriction is due to increased risk and other challenges.
4. Do my profit margins allow me to cover the cost of factoring?
The cost of factoring is higher than the cost of conventional bank financing. Typical rates range from 1.5% to 4.0% per 30 days. Rates vary based on your sales volume, invoice diversification, and customer credit quality. As a rule of thumb, factoring works best if your profit margins exceed 20% and your customers pay in 60 days or less. However, each situation is unique. You should evaluate factoring based on the benefits you expect to get.
5. Does my company have serious financial problems?
Factoring financing can be used by companies that have financial problems. It’s a common solution for companies that are going through a turnaround. However, keep in mind a few limitations. Your company must not be at immediate risk of bankruptcy. If your company is about to file Chapter 11, factoring can be used as debtor-in-possession financing.
Companies with tax problems must have a payment plan in place with taxing authorities before factoring can be deployed. The factor may need to be involved in forwarding payments to taxing authorities as part of their agreement. You need to consult the factoring company and an attorney.
6. Will my customers support my decision to factor invoices?
Factoring lines require some involvement from your customers. When you start factoring their invoices, your customers receive a Notice of Assignment (NOA). The NOA advises them that a factoring company is managing your invoices. It also requests they update their payment address. Factoring companies also verify your invoices regularly. This step helps ensure invoice accuracy. It is commonly done through your customer’s vendor portal (if they have one).
7. Do you have other financing solutions in place?
Factoring companies buy your accounts receivable as part of the transaction. During this process, they secure their position by registering a UCC filing. The factoring company must have the first position on your accounts receivables for the transaction to work. However, this positioning may not be possible if your company has existing financing.
Using factoring in combination with other financing is usually difficult. Most business loans, lines of credit, and cash advances are secured by your company’s assets. This arrangement prevents the factoring company from getting the first position on your accounts receivable. The only way to solve this challenge is to have your existing lender subordinate their position.
8. Will my company qualify for factoring?
You need to evaluate if your company qualifies for factoring. Most factoring companies check to see if your:
- Customers have good business credit
- Accounts receivable aging has eligible invoices
- Invoices are free of UCC liens
- Company has tax/legal problems
- Background meets their requirements
- Business meets their funding requirements
Get more information
Are you looking for a factoring quote? We offer high advances at low rates. For more information, call us toll-free at (877) 300 3258.