Is your small business dealing with outstanding invoices and slow-paying customers? If so, invoice factoring may be the answer to your cash flow problems. This is particularly true if you have net 30, net 60, or net 90 terms with your customers. Put simply, invoice factoring is when you sell your unpaid invoices to a factoring company in exchange for immediate cash. It's an alternative to small business loans and can benefit a variety of small business owners. Let’s take a closer look at how invoice factoring works so you can determine if it’s right for your unique business.
What is Invoice Factoring?
Also known as accounts receivables factoring, invoice financing, and spot factoring, invoice factoring is a financial transaction in which your business sells its unpaid invoices to an invoice factoring company. The factoring company will then pay you a percentage of the total value of the invoice. Once they collect payments from your customers, you’ll receive the remaining balance, minus a factoring fee.
With invoice factoring, you don’t have to wait weeks or months for your customers to pay you. Depending on the factoring company, you may receive anywhere from 70% to 90% of your total invoice value upfront. You canuse the cash to cover day-to-day operating expenses, pay down debt, or grow your venture.
Non-Recourse vs. Recourse Factoring
There are two types of invoice factoring you may choose to pursue including non-recourse factoring and recourse factoring.
Recourse factoring is the most common option and requires you to cover the cost of invoices that your customers don't pay for any reason. If you’re a stable business with reliable clients who usually pay on time, recourse factoring is likely the way to go. It might also make sense if you’d like to save the most money because it will allow you to sell your invoices at the lowest rates.
Since you’ll be responsible for any unpaid invoices, the factoring company won’t have to bear the risk of non-payment. This means you’ll likely get approved, even if you don’t have the best credit score. The greatest downside of invoice factoring, however, is that you put your business income at risk and may get into debt if you can't find a way to cover any unpaid invoices.
Non-recourse factoring differs from recourse factoring in that the factoring company accepts the loss for any unpaid invoices. They won’t be able to take recourse if your customers fail to pay you, unless the non-payment occurs due to fraud or negligence.
If you’re a newer operation or your customers have a track record of late payments or no payments, non-recourse factoring is certainly worth considering. With this option, you’ll receive your money and won’t have to take on any risk.
Just keep in mind that you’ll need to accept a higher factoring rate or discount rate and pay more than you would with recourse factoring. Also, non-recourse factoring is less common so you might have to do some research to find an invoice factoring service that offers it.
Invoice Factoring Rates and Fees
Since invoice factoring isn’t a business loan, line of credit, or business credit card, there are no interest fees. Instead, the factoring company will charge a factoring fee or discount fee. In most cases, it will range between 1% and 5% of the total invoice amount. Factors like your sales volume, customer's creditworthiness, the type of invoice factoring you choose (recourse or non-recourse) and how much your invoice is worth will determine your factoring fee.
If you go with recourse factoring, you’ll also have to repay the factoring company or lender in the event your customers default on their invoices. In addition, you might be on the hook for additional fees, which vary by factoring company. These may be application fees, processing fees, service fees, ACH fees, and monthly minimum fees.
What Industries Use Invoice Factoring
Invoice factoring has become a great option for a variety of businesses who invoice their customers after they deliver goods or services. The most common industries that use factoring include:
Before they deliver freight, transportation and trucking businesses must buy fuel, pay drivers, cover tools, reimburse suppliers, and more. That’s why many of them turn to invoice factoring for quick capital. Some also use it to build a fleet of trucks, hire and train drivers, and take their operations to the next level.
Oil and Gas
In order to pay bills on time, hire top talent, and invest in equipment, oil and gas businesses need sufficient cash flow. Invoice factoring provides them with the flexibility to accept new jobs and thrive in this rapidly growing industry. Additionally, it allows them to cope with slow-paying customers, cover day-to-day expenses, and put cash toward great opportunities.
Despite the fact the claims process is often delayed and insurance companies can be slow payers, healthcare providers must care for patients, purchase supplies, and pay employees. Invoice factoring can provide them with the fast cash and peace of mind they need to continue to operate and provide excellent patient care.
Most manufacturing operations invest in costly equipment, materials, and supplies before they sell their goods. With invoice factoring, they can remain productive and make these purchases with ease, even if customers take a long time to pay or unexpected expenses like broken equipment pop up.
Staffing companies must cover payroll and benefits for their workers. However, they often face long gaps between when they send out their customer invoices and when they receive customer payments. This makes itdifficult for them to pay their team consistently. Invoice factoring improves their cash flow and makes it easier to meet payroll.
Wholesale and Distribution
Wholesalers and distribution companies deal with the high overhead costs of supplies, utility bills, payroll, advertising, legal fees, and more. If they come across low-cost goods, they may not have the cash totake advantage of them. Invoice factoring can offer the working capital that enables them to pursue opportunities and save money in the long run.
While government contracting can be very lucrative, it usually takes a lot of time for invoices to get approved and paid. Invoice factoring provides government contractors with upfront cash to pay workers, suppliers, and anyone else involved in their project. They don’t have to worry about slow payments from the government and the cash in their bank account.
How to Determine If Invoice Factoring Makes Sense
If your business is in one of the industries we discussed above, there’s a good chance you could benefit from invoice factoring. It all depends on your business needs. Here are a few other reasons you might want to consider this form of financing.
- You invoice your customers: If you have payment terms of 30, 60, or 90 days on your customer invoices and have a significant amount each month, invoice factoring likely makes sense.
- You have no credit or bad credit: Since the quality of your invoices, rather than your credit will determine approval, invoice factoring can be a smart financing solution if your business doesn’t have the best credit profile and can't qualify for bank loans.
- You don’t have collateral: Many other financing options require you to secure collateral or an asset you own like equipment or commercial real estate. If you don’t have it, invoice factoring may be a solid alternative.
- You struggle with off-season cash flow issues: It can be stressful to manage cash flow as a seasonal business. Receivable financing should be on your radar if seasonal shifts lead to cash shortages.
- You’re a new or rapidly growing business: If you’re a startup or expanding your venture, invoice factoring can provide you with the additional working capital you need to meet your goals.
If you’d like your business to sustain positive cash flow, invoice factoring can help. As long as you understand and accept all the details and costs associated with a factoring agreement, it may steer your organization toward unparalleled success. When you’ve made a decision and are ready to apply for invoice factoring, reach out to us here at Cultiva Financial.