What Is Invoice Factoring and How Is It Used?
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How Does Invoice Factoring Work?
Recourse vs. Non-Recourse Factoring
Invoice Factoring Companies
Invoice Factoring Rates and Fees
Flat rate/fee: You pay a fixed percentage of the invoice to the factoring company and the rate doesn’t typically change even if the customer pays the invoice late. Depending on the industry you work in, flat rates are usually less common than tiered or variable rates. Tiered or variable rate/fee: A percentage of the invoice amount is regularly charged until the factoring company receives full repayment; the longer invoices go unpaid, the more you’ll owe in factoring fees. For example, a factoring company may charge a factoring fee of 1% every 10 days until the invoice is paid. In this example, if it takes your customers 60 days to repay, the factoring company would keep 6% of the invoice amount. Some factoring companies may increase the variable rate the longer repayment takes. The industry your business is in Your customers’ ability to pay their invoices The number and sizes of the invoices you wish to factor Your business’ stability and creditworthiness
Application fees: Charge for processing your application and setting up the account Invoice processing fees: Help cover costs for things like credit checks and record keeping Service fees: Charged in intervals to covers costs related to maintaining a current account with your factoring company ACH or bank wire fees: When funds are transferred between banks there may be fees which are passed on to you from the factoring company Early termination: Some invoice factoring companies may charge a fee if you decide to cancel your contract before the termination date Due diligence fees: Coverage for costs incurred whenever the factoring company needs to verify the creditworthiness of the customers paying the invoices
Invoice Factoring vs. Invoice Financing
Pros and Cons of Small Business Invoice Factoring
Pros of Invoice Factoring
No collateral: Invoice factoring is an unsecured type of financing, meaning you do not have to offer collateral, or a valuable asset, to be approved. Maintain healthy cash flow: Receive immediate cash to cover unexpected expenses or working capital, and maintain healthy cash flow in between invoice payments. May be an option for those with lower credit scores: If financing or a bad credit business loan is difficult to get elsewhere, invoice factoring may be an option because companies are focused more on the value of the invoices and the credit scores of the businesses that owe the invoice than on the credit score of the business that the invoice is owed to. Outsource invoice collection: For some businesses, it may be helpful to pass the responsibility of collecting on invoices to a factoring company so they can focus on other responsibilities. Spend on what you need: Unlike other small business loans (e.g. equipment financing), you aren’t restricted to spending the funds you receive on specific business expenses.
Cons of Invoice factoring
Factoring companies have control: After you sell invoices to a factoring company, they may end up collecting directly from your customers. It’s important that the company be reputable and ethical in their dealings with customers. It’s typically expensive: With various fees and relatively high rates, invoice factoring can be costly—especially if customers delay payment. Recourse if unpaid: Since there’s no guarantee that an invoice factoring company will be able to collect on unpaid invoices, they may expect you to pay for, or replace the invoice, possibly with additional fees. Approval may depend on customers: Invoice factoring companies want to make sure they will receive payment on the invoices they purchased from you. If your customers have a less-than-perfect repayment history, you may have a more difficult time getting approved.
Alternatives to Invoice Factoring
Inventory financing: Used to pay for products that will be sold at some time in the future. The inventory acts as collateral for the loan. Equipment financing: Used for the purchase of machinery, vehicles, or other business-related equipment. SBA loans: Backed by the U.S. Small Business Administration and offered by banks and approved SBA-approved lenders. Personal loans: Unsecured personal loans are based on your personal credit history (not business credit) and depending on the lender, may be eligible for business expenses. Commercial real estate loans: For the purchase of a real estate for business use such as an office space, warehouse, or storefront. Business line of credit: Gives you access to a maximum amount of funding with interest only charged on unpaid balances. Business lines of credit are typically revolving credit that function similarly to a credit card. Online business loans: Online lenders offer similar loan options as a traditional bank, but typically have a faster approval process and may offer more options for people with lower credit scores. Merchant cash advance: Allows small businesses (“merchants”) to get a cash advance for business expenses in return for a portion of their future sales or receivables
Choosing the Right Financing for Your Business
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