What Entrepreneurs Should Know About Invoice Factoring
The problems of continuous cash flow for your small business can be made worse if your customers are slow in meeting outstanding payments. Sometimes waiting for a payment can take up to three months. To alleviate this problem, some businesses have turned to invoice factoring. While this method can generate needed money to meet operating expenses, it is important to understand the drawbacks as well as benefits.
The benefits of factoring come quickly. A factor company will offer to buy your invoice for cash, usually for 70 to 90 percent of the value of the invoice, with the actual percentage depending on different factors, such as the age of the invoice or the amount of the advance. The factor company will then charge a small fee for their services. The cash payment is quick and takes five to ten days, or perhaps less. Once your customer has paid the invoice, the factor company will advance the remaining balance to your business.
In addition to quick cash, factoring can also help if you are turned down for a bank loan due to poor personal credit, inadequate collateral or a limited operating history. Factoring companies are primarily concerned about the value of the invoices you are looking to factor, not your credit history.
While invoice factoring can provide quick access to cash, it presents some pitfalls. Factoring is not a highly regulated industry. Research carefully the factoring company you are considering to ensure they are a reliable outfit. Don’t sign a contract without knowing how long the relationship between your business and the factoring company will last. Also, watch out if a proposed contract includes you making a personal guarantee on the invoice amount. If your customer defaults on the payment, the factoring company may come after your personal assets like your car, home, or bank accounts. Even if no collateral is required, you may on the hook for added interest fees if payments are late.
You should also consider how factoring can affect your relationship with your customers. If your factoring company is collecting the payment from your clients, you will want to be sure there will be no problems with the arrangement. Your customer may not approve of sensitive information being communicated to the factoring company.
There’s no question invoice factoring can offer immediate financial benefit to your business. However, since you are inviting a third party into a pre-existing arrangement between two parties, possible drawbacks should definitely be considered, especially if your relationship with your customer could be damaged.