Business clients in some industries can take more than one month to pay for the goods and/or services rendered to them. In such cases, companies can sell their invoices to third party companies known as factors. This method of business financing is known as invoice factoring.
Business invoice factoring is a practice that involves both small and large companies. However, small businesses in the manufacturing, transportation and medical sectors are often the most affected. Businesses make use of invoice factoring to achieve predictable cash flow.
It is good for a small business to maintain its daily cash operations and to avoid bad debt. Most businesses fail due to cash flow problems. Over the years, however, invoice financing has saved many companies from collapsing or going bankrupt. After setting up an invoice factoring account, detailed business information, including credit history is provided to the factor.
Upon approval of the documentation and satisfaction of any requirements provided by the factor, the business sends invoices to the factoring company. It then receives funding almost immediately. However, there are some common mistakes that most business owners tend to make yet they can easily be avoided.
Top 7 Invoice Factoring Mistakes You Can Easily Avoid
Forgetting to Read the Fine Print of the Contract
Fine print includes the terms and conditions of the contract. You wouldn’t want to sign a contract without reading it keenly. It is common for businesses, especially startups to rush into signing factoring contracts due to cash flow difficulties they might be experiencing.
Do not commit this mistake. The terms and conditions involve terms of repaying the money and any fees and penalties involved. If you don’t clearly understand what a contract stipulates, it’s best to consult and ask questions to avoid issues that may arise later.
Moreover, reading a contract fine print also helps you know whether your invoices are the type that can get you funding. Get various factoring agreements from various companies and go through all of them to find one with favorable terms and best meets your needs.
Failing to Pay Attention to the Factoring Application
Invoice factoring application is different from an application for a bank loan as it is short and precise. It’s important to provide the required information instead of giving detailed information that isn’t needed. First, read through the application to determine the specific information required so you can provide precise answers or the right documents.
You wouldn’t want to lose out on a likely invoice factoring funding due to such a small mistake. An invoice factoring agent is more interested in your business customers than your company. Be keen to only use invoices of customers who make prompt payments. Customers who don’t pay on time can cost you more money in fees due to delayed payments.
Using Wrong Account Set-up
Maintain a consistent accounting process to keep track of your factoring fees and advances to save you time. Don’t wait until it is too late. Tracking an invoice advance payment made more than a year ago can be stressful and time-consuming, wasting your business time.
Invoice factoring companies give 80% to 90% of the total amount your customers’ owe you, leaving only 20% or 10% as reserve amount. Once your customer pays the full amount of the invoice, you’re paid the balance less agreed upon fees. A good accounting system can keep track of all your transactions, letting you know how much fee should be deducted by your factor.
This helps ensure your gross profit doesn’t reduce as a result of using invoice factoring to fund your ongoing business operations. Invest in an efficient accounting system from the word go to keep track of your factoring expenses.
Creating a Strong Relationship with the Factor and the Customer
It’s important to develop a good relationship between you and the factor, the factor and the customer, and you and the customer. As a business owner trying to get a working capital from invoice factoring, connect your customer and the factor as payment is often made to the latter party.
Be clear when introducing your customers to the factor to avoid any suspicions or doubt they might have. Furthermore, reach out to your customers and inform them that when the invoice is due, they need to make payment to a different company. Let your customers know in advance that they’ll be receiving a call regarding invoice payments from the factor.
Provide the factor with your customers’ contact details and other important information. Share with your factor the credit worthiness of your customers so they expect prompt payments. Creating such relationships hone strong partnerships, in addition to making business invoice factoring more efficient for small businesses in need of quick funding.
Not Realizing the Invoice Requirements
Consult before submitting any invoice to your factor. Make sure you understand what factoring companies require to give you advance invoice payments. For instance, whereas some factoring companies ask for all invoices relating to a single customer, others only need one invoice from one customer.
The former argues that it is important to help determine a customer’s consistency in payment. Do not submit all your open invoices to a factoring company without proper understanding of their invoice requirements. Submit only the invoice you want funded and comprehend your factor’s invoice requirements. This can help prevent inconveniences that might arise in the future by doing otherwise.
Failing to Enquire about Upfront Percentage
As mentioned earlier, factoring companies pay up to 90% of your invoice amount as an upfront percentage. The remaining percentage is paid after your customer makes due invoice payment, excluding fees. Calculate your working capital by multiplying the upfront percentage you’re offered with your invoice amount to get your advance invoice payment amount.
Otherwise, you might have to source for more funds elsewhere. Although this is a common mistake, you can avoid it by understanding how invoice factoring works to ensure you get the capital amount you need. Know your upfront percentage beforehand and have it in writing to ensure you get the exact amount agreed upon.
Ignoring Factoring Fees
Most factoring companies charge fees depending on the time your customers take to pay outstanding invoices. Usually, factor fees start at 1% a month on your invoice value. Therefore, it is important to understand invoice factoring fees and related terms and conditions to ensure they don’t take up a great chunk of your gross profit margin.
Avoid these common mistakes often committed by small business owners to get the most out of invoice factoring. Business invoice factoring is a good way for startups and medium enterprises to source for funding of their working capital before customers make invoice payments. It can also help business owners avoid bad debt, and ensure efficient cash flow.
Contact us to learn more about invoice factoring and how you can get cash when other lenders let you down!