Business owners have the option of turning their pending invoices into cash right away through invoice factoring. This process involves selling the outstanding invoices to a factoring firm, who then collects the payment from the customers. If the business owner wants to remain in control of the invoices, invoice financing is a viable option. Both of these methods provide relatively quick access to funds.
Instead of a loan, invoice factoring is a form of financing in which you give up the invoices you have created in exchange for a lump sum of cash. The factoring company will then be the rightful owner of the invoices and will be paid when the customer makes their payment, normally within a span of 30 to 90 days.
- Financing amounts: Up to $5 million
- Approximate APR range: 10% to 79%
- Best for: Managing cash flow & short-term financing
For instance, if you own a hardware store, you have created an invoice amounting to $10,000 to another business and they have agreed to pay it off in 30 days. However, you need the money right away to pay your employees. This could be a problem since you have a cash shortage.
The fee for factoring, also called the discount rate, can stretch from 1% to 5%, depending on the amount of the invoice, the volume of your sales, the creditworthiness of your customer, and whether the factor is “recourse” or “nonrecourse”. The type of factor pertains to who is responsible for an invoice that is unpaid- either your business or the factoring company.
If the contract is a recourse factor and the customer does not remit payment, you could need to repurchase the unpaid receivable from the factoring company or substitute it with a more recent receivable of similar or greater worth. If it is a nonrecourse factor, you are not obligated to pay off or replace the unpaid receivables, but you will probably have to pay a higher transaction fee as the factoring company assumes the additional risk of not recovering its money.
The traditional bank option can be taken, but you would need to have excellent personal credit and a collateral (like real estate) that they can take if you fail to pay. You would also need to wait several months for the loan to be approved and this might be too long for you.
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Pros of Invoice Factoring
Fast cash: Immediate capital can be acquired via invoice factoring to bridge the financial gap resulting from clients who take long in paying the due amount.
Cash flow: You can keep your patrons on extended payment terms, but still have enhanced cash flow to build your business. Invoice factoring provides funding to enterprises that may be unable to get money from other sources like a regular bank due to lack of security, bad personal credit or a short tenure of operation.
Easier approval: Generally, factoring entities only view the worth of the invoices to be factored and the reliability of your customers.
No collateral: This type of financing is unsecured, implying it does not need collateral – such as real estate or stock – that the lender can take if you fail to settle the debt.
Cons of Invoice Factoring
High cost: Obtaining the service can be costly. You also have to beware of concealed charges, like application fees, processing charges for every invoice you finance, credit check fees or late fees if your customer is overdue on a payment. Delayed payments can provoke an escalation in your annual percentage rate, the yearly cost of borrowing money with all fees and interest included.
B2B only: Invoice factoring is most beneficial for businesses that work with other businesses since transactions involve invoices. Consequently, companies that sell or work directly with individuals won’t qualify for this option.
No guarantees to collect: There’s no guarantee that the invoice factoring firm will successfully collect on your unpaid invoices. If it’s a recourse factor, the factoring company may demand that you purchase back the unpaid invoice or replace it with one of equal or higher value.