In 2008, there were an estimated 27,281,452 businesses in the US alone. Now we’re in 2017, it’s likely that figure is even bigger with more people than ever deciding to branch out and start their own businesses.
Whilst becoming a business owner and calling the shots in your working life seems great, there’s plenty of hidden responsibilities many new entrepreneurs are unaware of. Keeping track of cash flow and invoices is crucial to ensure you’re always in-the-know about how well your business is doing financially. If at any point your cash flow is a little slow and you need an advancement to keep your business up and running, it’s vital you know so you can put a solution in place.
Invoice factoring is something many businesses engage in, simply because it’s a quick and easy way to get advances on your invoice payments. This simple guide will talk you through exactly what invoice factoring is, how it works, and why it could benefit you and your business’ money. So, if you’re keen to expand your existing knowledge of invoice factoring to see whether it’s something you could benefit from, keep reading!
What is invoice factoring?
In simple terms, invoice factoring is a financing option that converts invoices into quick cash for your business.
Available to businesses that invoice government agencies (B2G) or other businesses (B2B), invoice factoring requires you to sell your invoices to a factoring company for a small fee. Your chosen factor will then pay around 80% of the invoice’s value to you right away, then pay the remaining 20% once the invoice has been paid by the customer.
To learn more about successful factoring companies and how to be approved, visit BusinessFactors.com.
How does it work?
Whilst the general concept of invoice factoring is pretty simple, it’s not as easy as it sounds.
Here are the essential steps involved with invoice factoring you will be expected to go through:
Invoice your customer – Once your business’ services have been provided, issue an invoice as normal for the customer to pay you. But to qualify for factoring, it’s essential you specify to your customer(s) that the invoice(s) must be payable within a maximum of 90 days.
Sell your invoices – Once you’ve done your research, found the factoring company you want to work with and qualified, you now sell them all your invoices yet to be paid. Your chosen company will establish whether or not you meet their eligibility criteria, and will also investigate your customers to see if they pose any risk. As long as their procedure doesn’t flag anything up, you should be approved for financing pretty quickly.
You’ll both then sign a financing agreement outlining the maximum amount you can borrow at a time.
You’ll receive an advance payment – You’ll now receive an initial advance payment from the factoring company. Whilst advance rates are usually 80% of the invoice’s value, the amount you’ll receive will depend on the size of your business, transaction and any other risk factors the factor will need to consider.
The factoring company will also likely send out a ‘notice of assignment’ to your factored customers. This notice simply states that you’ve assigned the factoring company to be the receiver of invoice payments instead of you, meaning your customer’s money will go into a designated account set up by the factor.
Your customer pays the factoring company – Payment will now be made by your customer(s) within the specified 90 days.
You receive the remaining invoice balance – As soon as your customer’s money has been received by the factor, you’ll now get the remaining balance of the invoice minus the factoring company’s fees you’ll have agreed on when you signed the financing agreement. Fees usually range from 0.5% - 5% of the invoice value.
Whilst these steps are pretty standard across all invoice factoring programs, they may vary dependent on the lender and their terms. Some factors will extend invoice payment to 120 days as opposed to 90, and some will likely specialize in different invoice amounts. So, whether you want to clear invoices of a mere $200 or much larger amounts of $100,000, taking the time to research different factors is the best way to ensure you make the right choice for your business.
Hopefully, this quick and easy guide has answered any questions you may have had regarding invoice factoring. Whilst simple from the outset, invoice factoring includes a lot of different steps and procedures that are essential you understand before jumping in.
Melissa Cole is a small business analyst. She loves to help startups by posting her insights on small business and startup websites.