Small businesses’ financial problems and funding options differ quite considerably from those of giant corporations. In the latter’s case, they have access to more options, such as more accessible credit, asset selling, or debt restructuring. However, when a small business starts to experience financial troubles, sources for working capital are few and often more difficult to get. (1)
Lenders tend to be wary of financing small businesses, particularly those with financial problems. It is because traditional financial lenders rely on your creditworthiness to determine your ability to repay a loan. This is where invoice factoring comes into the equation to help small businesses face long wait times between delivery and invoice payment.
What Is Invoice Factoring?
In simple terms, invoice factoring sells your business’s outstanding invoices to third-party factoring to improve cash flow. Normally, cash flow problems stem from customers being unable to pay for products and services on time or not paying at all, causing the business to lose money. (2)
One of the benefits of invoice factoring is having access to capital. When you sell your unpaid customer invoices, you leave the factoring company to collect directly from your customers. In the meantime, you get the cash necessary to keep the business running without waiting for customers to settle their dues.
How It Helps Small Businesses
Invoice factoring essentially means selling control of your accounts receivable either partially or wholly to a third party. Here are ways it can help small businesses:
• Quick Access To Funding
Getting approved for a business loan can take months, but the wait time for invoice factoring is significantly shorter. There are cases where you may get funding on the same day you applied. This benefits your business considerably, especially if you need to pay your employees soon:
• Ongoing Cash Flow
Another significant benefit is that you can finance your working capital for as long as you need. If invoice factoring makes business sense in your situation, you can build a lasting relationship with a factoring company and make it a normal process. With that, cash flow issues can become foreign to your small business due to advance payments for your invoices.
• Outsourcing Invoice Collection
One of the most frustrating and challenging business tasks is debt collection. Not only is it time-consuming, it’s also difficult to keep track of customers with outstanding dues. Invoice factoring lets you delegate the task of debt collection to the service provider, letting you focus on more important matters.
In this case, your customers will be dealing with professional debt collectors who know how to collect dues without getting on their bad side. Apart from improving invoice payment time in the long run, it can also strengthen customer relationships.
• Serves As Collateral
In bookkeeping, accounts receivable are considered assets but not as critical to business operations as capital assets such as buildings, land, or equipment. The invoices you sell to a factoring company are all the collateral you will need. You don’t have to lose your capital assets or business shares, making it a less risky option.
• Cheaper Working Capital Financing Option
Compared to bank loans, invoice factoring offers a more affordable way of obtaining working capital. This makes it an excellent choice when looking to finance your business’s short-term needs. If you factor in the associated costs of tracking your creditors through calls, correspondences, or debt collectors, you can end up saving a lot more.
Generally, invoice factoring goes through the following steps:
1. The business provides goods or services to your customers in your usual manner and issues invoices accordingly.
2. The business then takes the invoices and sells them to a factoring company, which verifies their validity and pays the business a bulk amount for the invoices. Invoice factoring services usually pay up to 90% of the invoice amount as an advance payment. (3)
3. The factoring company collects or demands (if need be) payment directly from the business’s customers.
4. Upon receiving the full amount, the factoring company pays you the remaining percentage, less their fees. The fee depends on different variables, including the size of the invoices and the quality of credit. You can negotiate the fees with the factoring company before entering into an agreement, and it varies between factors.
Final Thoughts On Invoice Factoring
Invoice factoring is an excellent alternative financing method for small businesses, but it may not work the same for everyone. It is important to evaluate your business’s needs against the terms and conditions of invoice factoring. If possible, seek professional guidance first to know what you will be getting into.
References
1. “The Differences Between Large & Small Business Financing Options” https://smallbusiness.chron.com/differences-between-large-small-business-financing-options-3660.html
2. “How Does Invoice Factoring Help Businesses?” https://www.b2bnn.com/2021/02/how-does-invoice-factoring-help-businesses/
3. “Invoice Factoring Rates: Factoring Fees & Costs” https://solutionscout.com/invoice-factoring/factoring-rates/#:
