If you’re looking for alternative financing options, chances are you’ve come across invoice factoring or account receivable factoring. While the concept might be one you’re just discovering, the practice is one of the oldest financing options dating back 4,000 years to Mesopotamia.
Jump ahead to modern day and invoice factoring is a common practice used by small and large businesses in industries such as staffing, manufacturing, transportation, construction, oil & gas, and other B2B companies with collection cycles that impede liquidity. The process involves selling accounts receivable to a factoring company for a fee.
So why would you sell your accounts receivable? Simple. To improve liquidity and free up the cash tied to unpaid invoices.
Let’s review some of the benefits and challenges to using factoring as a finance option in the B2B space. We’ll also go over who factoring is ideal for and how to find a lender.
Benefits to Invoice Factoring
It’s hard to decide what to put first, simplicity or efficiency. When your business needs cash fast, you want a fast approval process as well. Here are some of the benefits:
- Maintain Liquidity: Your business receives cash immediately to help improve your current cash flow needs. With a more predictable cash flow, you can set and achieve financial goals.
- Speed: This applies to both the process of getting approved AND receiving cash, making factoring one of the most efficient ways to improve and maintain liquidity.
- Simplicity: While bank loans require credit checks and lengthy approval processes, invoice factoring is much simpler to obtain. The business only needs invoices issued for delivered work and those invoices to be payable by creditworthy customers.
- Improved Payment Terms: You will be paid by the factoring company when you present an invoice. Now you can offer longer payment terms such as net 30 or net 60. This offers increased flexibility to your clients, which won’t affect your operating cash.
- Customer Intel: Factoring companies will investigate your customer’s credit and decide your rate. This information can potentially assist with negotiations down the road.
- Delegated Accounts Receivable: By selling your invoices to a factoring company, you reduce the time spent in-house on chasing accounts receivable.
- No New Debt: Since the business is engaging in selling an asset (invoices), no new debt is added to the balance sheet.
Challenges of Invoice Factoring
There are several benefits to reducing financing costs by finding a lender who specializes in factoring for your industry. But all that glitters isn’t gold. There are a couple of items to consider before jumping into this financing option for your business.
- Confusing Fee Structure: It’s essential to work with a lender who is transparent about the fees and rate calculations. Rates typically range from 1%-5% on advances of 70%-95% of the invoice and vary by industry.
- Reduces Profit Margin: Since you’re paying to get your cash faster, you pay a fee for that convenience. Depending on what the money is being used for (payroll, expansion, new equipment, etc.), the overall profit margin reduction might be worth it.
- Time & Labor Intensive: For each advance, specific documentation needs to be submitted, such as a schedule of accounts, copies of invoices, and any backup documentation. Typically businesses do a lot of this online.
- Factoring Companies Contact Your Customers: This will primarily affect the clients who prefer to work directly with you. Additionally, you’ll want to ensure you choose a company with a good reputation that will also protect your business’s reputation.
Factoring is the Ideal Financing Option for…
We can see that there are a number of pros and cons to working with factoring. The primary benefits of getting cash quickly and having an additional financing option available for small or large businesses make factoring ideal for many situations.
- Businesses who have:
- Volatile cash flow
- Long sales cycles
- Seasonal sales
- Slow-paying customers such as large corporations or government agencies
- Businesses in growth mode that need a quick cash infusion to assist with:
- Unanticipated demand for products or services
- New opportunity to invest or expand in emerging markets
- Expanding with new technology or equipment
- Exciting opportunities to expand real estate footprint
Any business with receivables that needs to speed up cash flow to capitalize on new projects or ensure that operating expenses are covered can benefit from factoring.
How to Find a Lender
How do you find a lender once you’ve weighed the pros and cons? For some tips right now, check out our guide: 5 Things You Need to Know Before Looking for a Lender.
Thankfully you can find a lender and the right financing package using Liquid Ally. The benefit of using us is that we know the industry and your options so we can connect you quickly and effectively, at the lowest cost, with the best factoring services for your specific situation.
Contact us today to see how we can help. Read our Case Scenario on How Invoice Factoring Helps Increase Available Capital for more insight.