How Credit Risks Become Instant Cash Certainty with Factoring

Every business owner knows the stress of waiting on payments. Your company delivers exceptional service or products, yet your cash flow is held hostage by lengthy payment terms, delinquent payments, and non-payment. It’s a universal challenge, one that often seems like an unavoidable part of doing business. But what if there was a way to flip the script on credit risks and ensure your cash flow is as reliable as sunrise?

On this page, we’ll explore how invoice factoring does just that, helping your business avoid unnecessary credit risks, streamline processes, and grow stronger.

Traditional Invoicing Practices Are Inherently Risky

Operating on net 30 to 90-day payment terms presents several risks for B2B businesses, fundamentally impacting cash flow and operational stability.

Cash Flow Interruptions

The most immediate risk is to the business’s cash flow. Waiting for payments can lead to a mismatch between the timing of cash inflows and outflows. Businesses must often pay for materials, labour, and overhead long before they receive payment for their services or products, potentially leading to cash shortages.

Growth Constraints

Limited cash flow can also restrict a business’s ability to invest in growth opportunities. In fact, 43 percent of small businesses say they’ve missed opportunities for this reason, Xero surveys show. Without available funds, it’s challenging to take on new projects, hire additional staff, or invest in marketing and sales initiatives to attract more clients.

Credit Reliance

To bridge the gap, businesses might turn to credit lines or loans, which can increase their financial leverage and the associated risks of carrying debt. This reliance on credit can lead to higher interest expenses and reduce financial flexibility.

Customer Credit Risk

Extending credit terms exposes businesses to the risk that a client may delay payment further or default entirely. This risk is particularly acute in economic downturns or when dealing with new, unproven clients.

For instance, during economic downturns, we often see an increase in payment delays and defaults, which can have a cascading effect on suppliers and service providers. In 2023, for example, Canadian B2B businesses experienced a 13 percent year-on-year hike in late payments and a two percent increase in bad debt, Atradius reports.

Operational Disruptions

Managing a business with unpredictable cash flows requires significant effort and can divert resources from core activities. The uncertainty may also impact morale and the ability to meet obligations to suppliers and employees.

Opportunity Costs

The resources dedicated to managing delayed payments and the cash tied up in outstanding invoices could be used elsewhere, such as in research and development or expanding the customer base.

Invoice Factoring Turns Your Unpaid B2B Invoices into Instant Cash

Invoice factoring is a type of funding in which your business sells its accounts receivable at a discount to a third party called a factor or factoring company. This provides your business with immediate cash flow from its unpaid invoices, offering a practical solution to the cash flow challenges we just discussed.

The Factoring Process

• Invoice Issuance: Your business issues an invoice to its customer for goods delivered or services rendered, with payment terms usually set between 30 to 90 days.
• Sale of Invoice: Instead of waiting for the customer to pay, you sell the invoice to a factoring company. The factor then advances most of the invoice’s value to you, often within 24 to 48 hours. This advance rate can vary but typically ranges from 60 to 95 percent of the invoice value.
• Payment Collection: The factoring company assumes the responsibility of collecting payment from the customer according to the invoice’s terms.
• Final Settlement: Once the customer pays the invoice, the factor pays you the remaining balance minus a small factoring fee. This fee is essentially the cost of the service and can vary based on the total invoice amount, the payment terms, the creditworthiness of the clients, and the factoring agreement’s specifics.

How Credit Risks Become Instant Cash Certainty with Factoring

Invoice factoring mitigates several risks associated with invoice-based payment systems, enhancing your business’s financial stability and operational capacity.

Improves Cash Flow

By converting invoices into immediate cash, factoring alleviates the cash flow interruptions that businesses face due to extended payment terms. This immediate liquidity enables you to cover their operational costs, such as payroll, rent, and supplier payments, without the stress of waiting for customer payments.

Reduces Dependency on Customer Payment Timelines

Factoring shifts the dependency from when and how quickly customers pay their invoices to the reliability of the factoring company’s advance. This shift significantly reduces your business’s vulnerability to customer payment behaviour and economic fluctuations that might delay payment.

Lowers Credit Risk

The unique way in which factoring works and the services factoring companies provide directly reduce and eliminate credit risk.

Creditworthiness Assessment

When your business applies for invoice factoring, the factoring company evaluates the creditworthiness of your clients—not your business itself. This evaluation involves conducting credit checks to assess the likelihood that your customers will pay their invoices on time. This process is fundamental because the factor’s primary interest is in the receivables’ reliability and the debtors’ financial health.

Risk Mitigation

By assessing clients’ creditworthiness, the factoring company helps you identify any potential risks of default or late payments before they occur. This preemptive measure can be particularly beneficial if you operate a small business that may not have the resources or tools to conduct thorough credit checks on all your clients. The factoring company’s due diligence ensures that the invoices purchased are less likely to result in bad debt.

Improved Credit Management

The insights gained from the factoring company’s credit assessments can guide you in making informed decisions about credit terms and limits for your customers. This information can lead to improved credit management practices, such as adjusting terms for higher-risk clients or deciding not to extend credit to certain customers at all.

Risk Transfer

In non-recourse factoring, the factor assumes the credit risk for the customer’s inability to pay due to insolvency. This arrangement provides a safety net for your business against bad debts, a critical concern when extending credit terms to customers with varying creditworthiness. While this option is less popular than traditional factoring because it costs a little more and not all factoring companies offer it, recourse factoring can be a game-changer for some businesses.

Saves Time and Resources

The factoring company handles the collection process, freeing your business from the often time-consuming and costly process of chasing payments. This saving allows you to focus your resources on core activities, such as sales, product development, and customer service, rather than on credit management and collection efforts.

Provides Scalable Financing

Unlike traditional loans with a fixed limit, the funding available through factoring grows with your business’s sales volume. As your business increases its invoicing, it can access more immediate funding, supporting and facilitating growth without renegotiating loan terms or increasing debt levels.

Facilitates International Trade

For businesses involved in international trade, factoring can mitigate the additional risks of dealing with foreign customers, such as currency exchange risks and longer payment cycles, by providing immediate cash in Canadian dollars and offloading the collection process to experts familiar with international markets.

Enables Better Financial Planning

With more predictable cash flow from factoring, your business can plan its finances more effectively. This predictability helps in budgeting, forecasting, and making informed decisions about investments and expansion.

Reduce Your Collections-Related Risks with Factoring

Factoring allows you to manage customer credit risks and ensure your cash flow is as reliable as sunrise. If it sounds like the right solution for your cash flow concerns, request a complimentary factoring quote.