Invoice factoring for small businesses explained
Invoice Factoring is an alternative mode of financing for businesses in need of quick cash. In this type, a firm sells invoices to a factoring company (or simply factor) at a lower value. Factors play a prominent role in funding small businesses’ operations, and the industry is what keeps these players going despite off-seasons and low accounts receivable turnover.
For example, imagine your company supplies tires to several retailers in your area. You deliver the merchandise as soon as the retailers place their orders, but these clients will only pay after 30 to 60 and sometimes even longer. You agree to this leeway to keep loyal customers, but as a result, you use up most or all of your working capital.
A few months later, even before you entirely collect the previous invoices, the same clients order another batch of tires that you have to fulfill. To add to that, new retailers are starting to are starting place bigger orders that you have to fulfill, and you have to pay your operating expenses like rent, utility, loans, wages, etc. What do you do?
You can seek help from factors to lend you cash against your receivables and credit your account for each time a customer pays an installment. Invoice factoring for small businesses allows you to continue your production while waiting for your clients to pay their orders in full. Other factoring companies can also assume the responsibility of collection, primarily acquiring your receivables at a discount.
Whatever type of invoice financing for small businesses you choose, make sure that you’ll still be able to turn up profits despite going for this remedy. One way to cover for factoring costs is to charge your clients higher for term transactions and offer incentives to encourage them to pay in cash. This approach will keep your cash inflow at healthy levels. Moreover, you should still compel your clients to pay on time, considering that some factors will charge fees for late or non-payments.
Factoring process and best practices
When a factoring company steps in to provide you with much-needed cash, they will automatically review your clients’ credit reputation. Some factors may impose more stringent qualifications. Additionally, interest rates may vary depending on your customer’s creditworthiness or the result of the due diligence conducted.
When your customers get approved, the factoring company will give you cash equal to an agreed percentage of the invoice value. They will then collect and keep tab of all the client’s payments. Once the customer pays the invoice in full, you get slightly less than the remainder of the invoice amount, owing to the factoring costs that you have agreed on earlier.
The factoring company will clear the account once the entire invoice gets paid. On the other hand, if the client or retailer fails to pay in full, you will be credited with the total amount paid by your customer excluding the fees for factoring.
A provider may also offer a long-term deal with you. Ideally, you must agree to invoice financing for small businesses only if you will still earn a little out of your client’s purchase order, and when the working capital dwindled too much that it disrupts operations.
How to pick the right factoring company?
Factoring companies are largely self-regulated, and the good thing is that you can enter an agreement where all parties will benefit. As long as the terms, rates, fees, and all agreements are explicitly written in the contract; then you are on the right track.
Inquire about the fees that could arise out of the invoice program for small businesses. Don’t pay fees that are not on the terms of the agreement. Additionally, a section must be written to account for what will happen if a client or retailer becomes delinquent. Avoid factors that will penalize you heavily for nonpayment of client.
Why not take out a bank loan?
Banks offer cash loans at lower interest rates, but even with excellent credit, it will take a little longer to get approved for a loan than to sell your invoice to a factor. This program is attractive because of the speed of endorsement and flexible requirements. Factors will not require you to pledge collateral for bigger loans, whereas banks might only lend you money against an asset or some other form of security.
Another reason why you should consider factoring is that banks can only loan you as much as your credit limit allows. With factors, as long as your clients pay conscientiously, then you have a higher chance of getting approved for additional funding.
Also, factoring can be a form of asset-based lending, which does not affect your solvency and credit rating. These indicators are quite important for banks and investors if you are looking for long-term funding.
Invoice factoring for small business is also a viable choice to cover emergency expenses like worker’s compensation, equipment replacement, or damage repair due to fortuitous events.
Finally, if your company maxed out your bank credit line, then a good option is to sell your invoices at a discount. Worse is if you have bad credit or have just recently recovered from a form of bankruptcy that allows you to continue operations, you won’t be able to get a loan from the bank. A factoring company can help you recover in this case.
When used correctly, an invoice factoring program can save your business from losing important clients and can help you ensure that you pay your bills and your employees’ salaries on time. All businesses experience cash shortage at one point in time, which is why it is crucial that connect with a company that could provide you with a ready source of money any time.
Just always make sure to put the money to good use. Ideally, you must only spend such cash on additional income-generation activities to ensure that selling your invoices to factoring companies will be worth it.
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