Is Invoice Factoring a Good Way to Fund Your Business?

One of the biggest challenges entrepreneurs face is keeping their cash flowing while growing their business. Waiting for customers to pay open invoices often means you’re tapping into credit cards, lines of credit, and personal funds in order to pay everyday expenses like auto leases, equipment costs and rent. For some, invoice factoring may provide the cash flow they need to continue growing their business, but it also has some drawbacks.

What Is Factoring?

Factoring is a form of financing that allows business owners to get advance cash on their invoices before they’re paid. This type of financing is not based primarily on the credit of the business owner. Instead, it is based on the credit-worthiness of the client to whom you’ve issued an invoice. Keep in mind, if you’re doing business with individuals as opposed to other companies, the chances of being able to factor invoices is seriously hampered.

How Does Factoring Work?

When you issue an invoice to a customer, you send a copy of the invoice to the factoring company and they advance you a portion of the invoice. Depending on the company, your upfront payment could be as high as 80 percent of the value of the invoice. This means:

  • No waiting 30 or more days for payment
  • Instant cash flow
  • You can pay your bills in a timely manner

When your customer does pay their bill, the payment will be remitted to a lockbox that is controlled by the factoring company.

Do I Have to Factor All Invoices?

Some factoring companies allow business owners to pick and choose which customer invoices to factor. In other words, you will not have to factor every client. Individual factoring companies make the decision as to whether all invoices you submit to the client will have to be included; you should read your contract with them very carefully.

What Are the Downsides of Factoring?

Like anything else, factoring costs money. In effect, the factoring company is loaning you money against your future receivables. Some companies will charge administrative fees, handling fees, and may charge a number of other fees that could increase your cost of borrowing. If you’re considering factoring, it is very important that you research your options to make sure you’re getting the best deal available.

There are other downsides including interaction with your customer base. Anytime you turn a client’s invoices over for factoring, the company advancing you the funds will also take control of collections for those invoices. If you’re not careful about selecting a factoring company to partner with, you could have customer service issues. Additionally, a bad debt — where your customer does not pay their invoice — will also mean you have to pay the invoice to the factoring company, or at least the amount you were advanced plus the fee to the lender.

What Are the Upsides of Factoring?

One of the most significant upsides to factoring is that you get access to a significant portion of your invoices before they are due. This allows those who are self-employed and have significant monies tied up in invoices to improve their cash flow. We all understand that instant cash flow can make a significant difference in how we run our business. Better cash flow allows us to take more risks with our business and may allow us to negotiate larger deals.

Another interesting upside to factoring is it often gives you a better understanding of your clients’ financial stability. In nearly all cases, factoring companies will run extensive background and credit checks on the customers and vendors who owe you money from invoices, allowing you to better understand how much of a risk you are taking when signing a contract with those clients.

What Types of Invoices Can Be Factored?

As previously stated, if you are doing business with individuals versus with other businesses, you’ll be less likely to be able to factor your invoices. However, those who are self-employed are often in a position to bid on and win large contracts with large companies, medium-sized companies, and even government contracts. These are the ideal types of invoices to factor since they are backed by larger entities.

Many people who are self-employed think that their options for financing to grow their business are extremely limited. While factoring may not be right for everyone, those businesses that rely on having sufficient cash flow to purchase materials or sign new contracts often see it as a benefit. No single type of financing is right for every business owner so it is important to thoroughly research all options before making a final decision. If you decide factoring is right for your needs, make sure you work with a reputable company and that you review your contract very carefully before making a final agreement.

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  2. […] repeatedly. Investors will be afraid to lend you any money due to a bad credit score in the past. Factoring is one of the solutions if you have a low credit […]

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