What Is Invoice Factoring And Do Businesses Need It?

what is invoice factoring business invoices

As a small business owner, you know how crucial it is to keep the cash flow going. Money is the lifeblood of any business and, as the saying goes, you need money to make money. However, if most of your finances depend on clients paying you on time, what happens if these clients are slow to pay? 

About 29% of small businesses fail because they ran out of cash. Of course, you want your business to succeed, but what can you do about the unpaid invoices that are causing your business to stall? 

Invoice factoring may be the solution you’re looking for. With it, you can turn outstanding invoices into fast cash that you can use to keep your business running. 

To learn more about invoice or debt factoring and how it works, please continue reading. 

What Is Invoice Factoring? 

You are wondering what to do with the unpaid invoices or accounts payable? Sell them! 

Instead of waiting 30, 60, or even 90 days to be paid, you can sell your invoices to a factoring company. A factor can give you the money upfront so you can get your finances in order right away. Collecting invoice payments now becomes the factor’s responsibility. 

Technically, the money is neither a loan nor a line of credit. There is no collateral required and no APR, although you do have to pay a modest factoring fee. 

How Does It Work? 

Most invoice factoring companies purchase your invoices in two installments. The first covers the majority of the account receivables, typically 80 to 90 percent of the face value. This is money that you can use immediately to keep your business operational. The factoring company then commences with the collection of payments from your customers. 

When the invoices are paid, the factor will remit the remaining balance, minus a factoring fee. The factoring fee, on average, ranges from 1.5 to 5 percent of the total value of the purchased invoices. 

What Determines the Factoring Fee? 

A factoring company sets the fee depending on how risky taking on your unpaid receivables would be. For example, the type of contract (if it is recourse or nonrecourse) can influence the rate of the factoring fee. 

Recourse means that if a customer doesn’t pay the factor, you may have to buy it back or replace it with a more recent one with an equal or greater value. The risk for the factoring company is lower and for this reason, you can negotiate for a lower fee as well. 

For a “non-recourse” contract, you are not obligated to repay unpaid invoices. In this case, the factor may set a higher fee to compensate for the added risk of not getting some of their money back. 

Is It the Right Thing to Do for Your Business? 

The obvious advantage of invoice factoring is that your business can get a quick influx of cash. This is an immediate and safe source of financing so you can do “what is best for business.” The cash flow may be what you need to keep your business afloat or to help it grow. 

Invoice factoring is not all rainbows and butterflies though. You do have to pay the factoring fee which might be too much if you are on a tight budget. It could also affect customer relationships since you’re allowing a third party to collect payments. 

Weighing the risks and rewards, it is up to you to decide if invoice factoring is the right thing to do. For more business invoicing tips and advice, feel free to browse the Finance section of the Bootstrap Business Blog now.

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