Invoice factoring is designed to solve one specific problem. If you have this problem, factoring solves it and improves your cash flow. However, if you don’t have this problem, factoring invoices won’t help you that much.
Is this you?
Do you sell your product and/or service to commercial clients who demand payment terms? If you are like most small business owners, you work with clients who pay invoices in 30 to 60 days. You have little choice about it: you have to offer terms or risk losing the customer. The problem is that many small business owners cannot offer terms because they cannot afford to wait for their payment while trying to grow their company at the same time. If you have this problem, factoring can help. Actually, invoice factoring was designed to solve this specific problem.
What will factoring do for me?
Factoring improves your cash flow by accelerating the revenues tied to slow-paying invoices. This solution gives you the liquidity you require to operate your business and enables you to offer terms to clients. However, factoring helps you only if:
- Your customers have good commercial credit
- Your sales gave high profit margins (15% or higher)
- Your invoices are not pledged as collateral
- Your invoices are for net 30 to net 60 terms
How does factoring work?
The transaction is relatively simple. A factor finances your invoices in two stages. The first payment, the advance, covers about 80% of your invoice and is wired to your bank account as soon as you deliver your product or complete your service. The remaining 20% is rebated, less a fee, once your client pays their invoice in full on their usual terms.
A factoring program has a number of advantages. It’s easier to qualify for this type of funding than for a conventional business loan. Also, the line can be deployed quickly and does not require months of underwriting and decision-making. But, more importantly, the line supports growth as it can increase as your revenues grow.
However, this solution also has some disadvantages. Financing your receivables usually costs more than conventional funding, so it can help only if your profit margins are high. Also, factoring requires regular customer communication because your factor verifies your invoices. For many companies, however, the benefits outweigh the disadvantages.
Not a place for bad invoices
If your cash flow problems originate from bad invoices – either because your customers are paying very slowly (more than 90 days) or have disputes – factoring will not help you. Actually, financing troubled invoices is usually counter-productive and can be expensive. If you have a problem with bad invoices, consider seeing a barrister or a collections specialist.