Every small business owner recognizes the importance of cash flow to keep the business going. However, a busy entrepreneur doesn't always have the time to spend chasing up unpaid invoices in amongst everything else that needs to be done to keep a business running.
When invoices go unpaid for long periods of time, it becomes more challenging for an entrepreneur to keep up with other business expenses. Fortunately, there are ways to turn those unpaid customer invoices into cash that could keep a business operating smoothly.
What is Invoice Factoring?
Invoice factoring is the term used for selling invoices to a factoring company. It's not a loan or a type of financing, as there is no debt involved in the transaction. Instead, the business owner agrees to sell unpaid invoices in exchange for a lump sum of cash.
The factoring company is then responsible for collecting payment. The company chases the customer for payment and then collects a fee of the amount paid to cover their costs.
The business owner may receive the majority of the invoiced amount within a few days. The remaining balance owing is paid after the customer completes the payment to the factoring company.
Benefits for Business Owners
Most business owners understand how the factoring process works. What they may not realize are the benefits it can offer a small business. Some of the bigger benefits include:
- Fast cash: Access to working capital can help keep a business's cash flow stable. Factoring means cash is coming into the business now, instead of waiting another 60 or 90 days for that money to arrive.
- Better terms with suppliers: If your own customers take 60 or 90 days to pay their invoices, you are at risk of being past-due in paying your own bills to suppliers. By comparison, selling some of your invoices can mean accessing the necessary cash to pay your suppliers on time, which improves your chances of securing better terms.
- Reduce administration: Busy small business owners often don't have time to chase up delinquent customers with past-due invoices. Selling those invoices to a factoring company frees up administration time and costs in return for cash flow. The factoring company follows up the customer for payment, saving a business owner time and money overall.
- Easier approval: Not all small businesses will qualify for a traditional bank loan, so it can often be difficult to raise enough capital to fund purchases. Invoice factoring companies provide access to financing options that allow small businesses to raise the capital needed.
- No debt: Selling unpaid invoices means incurring no debt. By comparison, borrowing money from a bank or financial institution to cover working capital can impact business cash flow as it tries to keep up with repayment obligations over the loan term.
Using factoring wisely can be a smart way for any entrepreneur to access working capital without applying for traditional bank loans or incurring any debt. It can also provide a way to keep cash flow steady.
Disadvantages of Factoring
Before making a decision about whether invoice factoring will be the right option for your business, it's important to understand the drawbacks or disadvantages associated with it. Some common disadvantages include:
- Costs: Selling your unpaid invoices can be costly. The factoring company will charge a fee, which is usually calculated as a percentage of the amount being collected. Some companies may also charge application fees, processing fees, credit check fees or late fees.
- Long contracts: Factoring might provide fast cash solutions, but some companies may require a business owner to commit to a long contract agreement.
- Reliance on customer credit: If some of your customers have bad credit or a history of late payments, the factoring company may offer a much lower amount than you expected, or may charge higher fees.
Choosing a Factoring Company
There are plenty of different companies offering factoring options for small business owners. Factoring Directory is a comparison site that allows entrepreneurs to search the available options from a range of listings. Before making a decision about which company to use, take the time to read through the contract in detail.
Understand the fees and charges associated with the process and know exactly what procedures the factoring company will use to collect payment on the invoices. After all, they'll be dealing with your customers. Always check the contract terms before committing and try to negotiate the term to suit your own needs.
After you've completed your due diligence you're in a much stronger position to determine whether invoice factoring is right for your small business's cash flow needs.
Kyle Griffin is a business consultant who shares his invaluable business tips online to help business owners take their company to the next level.