At FundFind Lending we offer a variety of Accounts Receivables Invoice funding. From traditional Invoice Factoring to Invoice Purchase and Invoice Line of Credit. We pride ourselves in providing non-notification options where we will not contact your clients to collect payment on outstanding invoices - keeping the full control of your business cashflow in your hands.
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In this article we'll discuss the pros & cons of traditional Invoice Factoring and things to keep in mind as you make the decision to use this finance method for your business.
Pros & Cons of Invoice Factoring
When it comes to running a business, cash flow is everything. A steady stream of money lets you pay salaries, take care of operation costs, and invest funds to expand the company, but there are a lot of pesky factors that can block the flow of money and put your business at risk. That’s where invoice factoring comes into play.
When a business sells a service or a product to a client for an agreed-upon price, it can take up to 30, 60, or even 90 days to actually receive the money. That’s a long time to wait while bills are piling up. You might consider getting a business loan to cover expenses, but loans can be challenging to get approved for, and interest rates get expensive fast.
A safer, less expensive option is to use invoice factoring to gain access to your company’s outstanding receivables at any time. In this article, we are going to look at what invoice factoring is, the pros and cons, and who would benefit most from it.
What is Invoice Factoring?
Depending on who you do business with, the time between completing a job and receiving the money from the invoice can take months. However, a company has the option to sell those invoices at a discounted rate to financial firms and receive an immediate deposit. The firm that purchases the invoice will then take full control over collecting payment from the client. This method of selling invoices to expedite payment is known as invoice factoring.
Instead of being paid by the client, you will now be paid by the factoring firm that purchased your invoice at a reduced rate. It is a simple method that brings a level of stability to your business, but it comes at a price.
When the factoring firm buys your invoice, it will give you a cash advance worth around 80% of the invoice amount. Once the firm is able to collect payment from the client, you will receive the remaining balance of the invoice minus factoring fees and other costs which usually come out to be 1% - 5% of the total.
Invoice factoring can be game-changing for companies who are held hostage by unpaid invoices; however, there are pros and cons to consider before committing to this type of financing.
Let’s first take a look at the pros of invoice factoring.
Pros of Invoice Factoring
The number one benefit of invoice factoring is clearly to have a consistent flow of cash, but what does this do for you? Business is dynamic, and there are constantly new challenges, hurdles, and opportunities; if you do not have money to play ball, then you can kiss your dreams goodbye.
Invoice factoring puts a steady stream of money into your pocket, allowing you to handle day-to-day operations, take care of payroll, and pounce on new business opportunities.
Selling invoices can be a great way to put the ball back into your court and make the moves you have not been able to afford.
Invoice factoring is not as risky of a financial commitment as it is for a traditional business loan because it does not require any collateral. That means even in a worst-case-scenario, the factoring firm or bank will not be able to seize any of your assets. A loan without collateral is known as an unsecured loan.
Depending on the contract you agree to, the factoring firm may take on all risks and responsibilities in the event of a client who is unable to settle an invoice. Businesses can be fragile, and things can happen like a crashing economy, lawsuits, or a loss of funding, which can make waiting for a client to settle an invoice a nerve-wracking experience. However, if you can agree to a non-recourse factoring contract, you will not have to worry about that anymore – well, a client who can’t pay is still a problem, but you won’t have to worry about bouncing checks.
Getting approved for invoice factoring is done through a quick and easy application process. It can usually be done online, and once you have been accepted, you can start receiving cash almost immediately. Compared to the approval process for a traditional loan which can be rigorous, intrusive, and time-consuming, invoice factoring is a walk through the park. In fact, you probably won’t even need a credit check.
Cons of Invoice Factoring
Cuts into Profits
Invoice Factoring is an easy way to get cash in hand, but it comes at a price. Most factoring firms offer to buy your invoices at a 1% - 5% discount – that’s money out of your pocket. The reduced price will cut into your profit margins and potentially impact your yearly budget. So, before you apply for invoice factoring and sign a contract, take a hard look at your books and see if you can afford to shave 5% off your profits.
However, it is important to note that it is not necessary to sell all your invoices. You will be able to pick and choose which clients’ invoices you want to sell to meet your cash inflow needs.
Factoring Firm and Client Relationship
Developing a healthy relationship with your buyer is important, and factoring can help make it flourish; however, when you work with a factoring firm to collect accounts receivables from your clients, you are inviting a new entity into your relationship. It is important to make sure that the firm you choose will not rock the boat and ruffle your client’s feathers.
Do your due diligence when picking a factoring firm. It will save you a headache down the road.
Although invoice factoring takes the pressure off tracking down clients for payments, it doesn’t always excuse you from a customer that is unable to pay an invoice. If you are not under a non-recourse factoring contract, then you will have to cover the unpaid invoice out of pocket – that’s bad business. The non-recourse contract is a great way to eliminate this collection risk, but it tends to cost more, so you will have to shave off another portion of your profits. Regardless of whether or not you choose to use invoice factoring, clients that are consistently unable to make payments may be the sign of a bigger problem that requires a different strategy.
Most factoring firms require a contract agreement of one to two years, and if you need to break the contract early, you might find yourself paying a hefty fee. One or two years might not sound like a long time, but it is still an important factor to consider before signing the dotted line.
Remember, selling your invoices to a factoring firm takes away a portion of your profits, and it is essential that you feel the value of immediate payment outweighs receiving 100% of your profits for the next couple of years.
Who Should Use Factoring?
Any company with outstanding receivables could be a good candidate for invoice factoring. As long as the invoices are worth a decent sum of money and your customers are reliable, the process and benefits of receiving a cash advance should be a walk-off home run.
It is a great option for companies that do not want to open a traditional line of credit but are looking to increase cash inflow and expand the business. In addition, a company that is just starting out is guaranteed to meet a bit of turbulence along the way, and invoice factoring can be a great way to relieve some of the early growing pains.
The decision to use invoice factoring comes down to each individual and company, and it is always wise to consult with an expert to make the right choice.
Invoice factoring is a unique type of financing that can offer you a lot of benefits. If your company is suffering from inconsistent cash flow, then selling your invoices for immediate cash could be an excellent option. However, there are things to consider like reduced profit margins and collection risks. No matter what, invoice factoring is a great system to know and understand.