How invoice factoring can help you out of a business cash shortfall

Business owners know that timing is everything when it comes to their customers paying their invoices. Unpaid invoices can leave your business in a jam when it comes to your cash flow even if a client’s payment isn’t late yet. Invoice factoring can help you get the cash you need to run your business when you have pending invoices. Here’s what you need to know about invoice factoring and invoice financing, and whether it’s a good option for your business.

What Is Invoice Factoring and Financing?

Invoice factoring involves selling your pending invoices at a discounted rate to a company for a single money payment. It’s not considered a loan because the company you sell your invoice to takes over possession of your invoice and gets paid when your customer pays. Most businesses collect on your invoices within 30 to 90 days, but if you can’t wait that long and need money to run your business now, an invoice factoring company can help.

Invoice financing works similarly, but a few of the terms are different. Instead of selling your invoice to a company, you use it as collateral to get a cash advancement. You are still responsible for collecting payment from your client. You have to repay the invoice financing company in weekly or monthly payment plans regardless of whether your client pays you or not.

When Can I Use Invoice Factoring?

Small business owners can use invoice factoring when they have pending invoices and need cash before the client has agreed to make a payment. For example, if you own a store that sells a product or a service to a client and your client agrees to pay their invoice within 30 days, but you need money now to pay your employees, you can use invoice factoring to get cash now.

Invoice factoring is not a traditional loan; therefore, you won’t need perfect credit or collateral to use it. In some cases, you may qualify for a loan from a bank but will need to wait several months for the loan to close before you can use it. That won’t help you if you need money to buy supplies by the end of the week.

How does Invoice Factoring work?

Invoice factoring companies buy your invoice in cash minus a factoring fee. Most factoring fees are right around 3 percent. So if you have a $10,000 invoice, a factoring company will buy it for $9,700 in cash minus the $300 factoring fee of 3%. Within a few days, the company will pay 85 percent of your invoice, or $8,245. Then, they collect on the invoice when your client pays for it and provide you the rest of the balance that’s owed, which would be $1,455.

Depending on the company, the factoring fee can range from 1% to 5%. It’s also known as the discount rate. Determining factors include the amount that the invoice is for, how creditworthy your client is, your sales volume, and recourse or nonrecourse determining factors. A recourse factor is when you and the invoice factoring company have an understanding that the company will buy back any invoices that your client doesn’t pay on so that the invoicing factoring company is not stuck with the debt. Approximately 90 percent of factors are recourse to avoid taking a risk on an unpaid invoice. On the other hand, a nonrecourse factor is a higher risk transaction, and the invoice factoring company might charge a higher rate because of it.

fee from 1% to 5%

If your contract is a recourse factor and your client sticks you with the bill, you will have to repurchase it from the invoice factoring company or trade collateral for it, such as a piece of real estate. A contract that is a nonrecourse factor means that you’re under no obligation if the client doesn’t pay it, but the invoice factoring company might hit you with a higher fee to buy the invoice.

Pros and Cons of Invoice Factoring

Invoice Factoring PROS

You won’t have to put up collateral. Because invoice factoring is unsecured, you won’t have to worry about your property or inventory being seized if your client doesn’t pay.
You’ll get cash within a few days as opposed to whenever the client pays. Invoice factoring provides you with money now to cover gaps in between customers who take their time making a payment.
Getting approved is easy. Even if you can’t get a loan from a bank because of bad credit or a lack of collateral, you can easily get approved for invoice factoring. In most cases, the invoice factoring companies only care about how creditworthy your client is and what the value is on the invoice.
You’ll gain a steady cash flow. Your customers will like that you aren’t rushing them to make a payment while still being able to earn enough cash to run your business.

Invoice Factoring CONS

There is no guarantee your client will pay their invoice, which means you will be stuck with buying back the bill if your client doesn’t pay. Or you’ll have to replace it with one of equal or higher value. Either way, it’s money out of your pocket.
A client’s bad credit could affect your factoring. You are putting your business finances in your client’s hands when you trust them with an invoice. Additionally, the invoice factoring company will want to check out how reliable your client is at making payments on time. If they have a history of not paying on time or not paying at all, the invoice factoring company has the right to deny you their service.
You’re no longer in control over your business transaction. Because the invoicing factoring company now has the right to collect on the invoice directly, you don’t know how they are treating your customers when dealing with them, which could turn them off from doing business with you in the future.
You may end up paying more than the invoice is worth. Using an invoice factoring company can be expensive. They have to cover their end to make sure they get paid when taking a risk on your client. Because of this, you might be charged extra, especially if you’re entering a nonrecourse factor contract.
You also need to watch out for additional fees, such as application fees, credit check fees, late fees if your client makes a past-due payment and a processing fee for each invoice. These charges can add up, making the service more expensive than what it’s worth to get the money up front. Additionally, late payments can raise your annual percentage rate, which is the yearly cost of all interest and fees associated with using the service.

What Are My Options?

There are two main options for invoice factoring or financing - BlueVine and FundBox

BlueVine is a company that offers invoice factoring. The company lends up to 2.5 million dollars, making it a good option if you need a large amount of money financed. They will advance up to 95% of your client’s invoice upfront and then pay you the rest when you client pays. They have a grace period of up to 12 weeks after they loan you the money. The only drawback is that they charge 1% in fees per week after that.

Amount loaned: $25,000 to $2.5 million
Length of time you have to repay loan: one to 12 weeks (before fees)
APR: 17% to 60% depending on how you qualify
How long it takes to get your money: three days maximum

FundBox is an invoice financing company that will give you 100% of your invoice upfront. They ask that you pay them back in 12 or 24 equal repayments, but they will charge a fee. If you have bad credit or want to avoid having a credit check run on your business, then FundBox if a good option for you. It’s also a good choice if you need a smaller amount financed from your invoice.

Amount loaned: $1,000 to $100,000
Length of time you have to repay loan: 12 to 24 weeks
APR: 16.4% to 67.7% for 12 weeks or 18.5% to 76.5% for 24 weeks
How long it takes to get your money: three days maximum