Invoice factoring is a simple way for small businesses to get funding. While invoice factoring may seem complex, it provides funding for your business if application is done correctly. Another advantage is when your customers are ready to make invoice payments in time as they promised.
Compared to bank rates, invoice factoring rates are favorable to every person in business. It enables you to maintain a good cashflow for your business as you can sell an invoice that is due in three months to a factoring company.
Invoice factoring involves two payments. The first is 80% of the invoice amount that is given to your business upon selling the invoice. The second payment is the remaining 20% that is paid when the invoice matures and the client makes the due payment. A factoring fee is deducted from this second payment to cater for the services of factoring.
Factoring companies work on the basis that your customers will not fail to pay for the invoice. In business, allowing your customers to pay at a later date, builds customer loyalty and satisfaction. However, allowing payments at later dates can also affect your business cash flow.
Factoring companies keep your business afloat by providing cash so you can continue with your normal business operations.
Steps of Invoice Factoring
There are four steps involved in invoice factoring:
Step1: Selling the Invoice to the Factor
Before you can successfully get funds, you have to submit a due invoice to your factor. The factor analyzes your eligibility and reviews your customer’s credit risks. The information on your customer and business determines whether you get the funding or not.
The factor then approves the information and signs the financial agreement. The agreement includes the maximum amount you can be granted.
Step 2: Receipt of Advance Amount
The rate varies from one company to another, but ranges from 70% to 90% of the invoice amount. At this stage, the factoring company may reach out to the customers whose invoices you submitted to them. The factor lets the customer know that they should make the payment to them.
All the invoices you factored are handled by the factor. The remaining 20% is paid once your customer makes invoice payments when they are due.
Step 3: Your clients pay for those invoices at the right time
Step 4: You will receive the second batch of payment less the factoring fees and the service fees.
Is It the Right Choice for You?
Invoice funding requires your business to be dealing with other businesses or government as clients. To be eligible, your clients must also be in a position to pay. The invoices you are to submit should be due within a period of 3 months maximum. These are general requirements provided by most factoring companies.
However, each company might have a unique condition depending on its terms. Is invoice factoring the right choice for you? You may have qualified for one, but do you really need it? The flexibility of invoice factoring allows you to maintain your business cash flow. It’s important to only source for business financing when you actually need it.
Invoice factoring rates are much lower and affordable than a merchant or bank rates. It is easier to get funds through invoice factoring as long as you have clients who are ready to pay on time.
Do your research to find out the invoice factoring company you want to work with. Note that some factoring companies have hidden fees that can alter your budget.
Moreover, each company has its own terms and regulations you have to understand before transacting with them. Some companies have higher factoring rates than others. You’ll also find those with minimum dollar amount of invoices they can receive monthly.
Invoice Factoring Costs and Payments
Discount rates determine the cost of invoice factoring. It usually starts from 1% of the invoice amount. This is the cash deducted from the second and last payment that’s often made once your customer pays for the invoice.
Suppose company Z gave goods worth $100,000 to its customer, company X. Company Z generates an invoice it sends to its customer X and the factor. Within 24 hours, the factor verifies if the goods were indeed delivered. It then advances company Z with a 90% value of the invoice, translating to about $90,000.
The factor then waits for company X to make payment of $100,000 from which it deducts 1% as fees. If the factoring rate is 5%, company X gets paid the remaining 4%.
Choose the Best Factoring Company
Choosing the wrong factoring company can lead to loss of revenue or even loyal customers. Do your due diligence and choose the best company to offer your business invoice factoring services. Although factoring companies offer the same services, they differ in how they operate and their terms and conditions.
Factoring rates and service commissions differ from one company to another. Make sure you choose the right company to finance your business through factoring services. A company’s reputation is important when deciding to transact with it. It is vital for you to research on the particular company. Check customer reviews online or call individual clients you know that have worked with the factor.
The company should have extensive experience financing many clients through invoice factoring. Companies that have been in the industry for a while understand the factoring process well and have a viable source of funding. Find the best and most competitive factor rates.
Financially, higher rates aren’t in the best interest of your small business because the goal of every successful company is to minimize costs. You may have to look around for the best rate. However, the lowest rates might not always be the best either since terms and conditions always apply.
Most factors charging lower rates usually don’t have favorable terms and conditions for their services. Paying for better services from a reputable and experienced company may be worth the extra cost. The factoring terms agreeable to both parties also determine what factor to choose.
Make sure you read a factor’s terms and conditions and understand them before signing the papers. If you don’t understand anything, make sure you ask.
Contact us to find out more about alternative small business financing and what you need to know about invoice factoring.