Too often, small business owners run successful companies but find themselves strapped for capital at the same time. This can lead to serious situations in which you don’t have enough cash flow for your everyday operating expenses, or it might even mean that you cannot make payroll or take advantage of business growth opportunities – that’s why factoring invoicing is an essential financial tool.
Factoring invoicing can be a valuable tool that allows you to tap into capital that’s locked up in your business without having to take on additional debit. What is factoring invoicing and how does it work? We’ll discuss that and much more.
What Is Factoring Invoicing?
If you’re not familiar with the term factoring invoicing, don’t despair. You probably know the process in question, just under a different name. It’s also called invoice factoring or debt factoring, and it can be a highly beneficial solution for small and medium sized businesses lacking in cash flow but with assets to their names.
Really, this situation is no different from selling any other asset that your company might own in order to gain access to liquid capital. In this situation, you’re not selling excess equipment, fixtures or inventory, but invoices.
You sell an invoice to a factoring company. That company then advances you a portion of the invoice total that can be used immediately for anything you need, whether that’s paying employees, buying new merchandise or supplies, or taking advantage of capital to grow your business. Once your customer pays the invoice, you’ll receive the remainder of the amount due (less a factoring fee based on the amount of the invoice).
It sounds simple enough, doesn’t it? It is, but there are things you’ll need to know before you decide that factoring invoicing is the ideal path for your business.
In the following sections, we’ll dig into some of the most frequently asked questions about the process so you can see exactly how it might benefit you.
Is This a Loan?
No, factoring invoicing does not require that you take out a loan, a line of credit or a merchant cash advance. In fact, this is not debt at all (despite the name debt factoring sometimes being used to describe the process). It’s the sale of an existing asset, nothing more.
In point of fact, you actually already own the capital that you’ll receive from selling the invoice. You just can’t access it yet, since your client has not paid their bill. This means several different things for your business, including:
- Because this is not a loan or line of credit, you do not take on any additional liability.
- Because this is not a loan, you do not need to worry about your company’s credit score or history. It has no bearing on the process at all.
- Because this is not a loan, you are not putting your company deeper into debt, which is always a benefit.
- Because this is not a loan, you can scale factoring to meet your needs by selling all invoices from a particular client over time, or selling multiple invoices at once to meet cash flow needs.
So, you can take all the worries about incurring yet more debt for your business off the table.
Do I Give Up Control Over My Customers?
No, you do not give up control over your customers. They’re your clients, and they will remain so for the duration. However, you do give up some element of control, but many small business owners actually find this beneficial. Many factoring companies will actually work as your billing and collection department, allowing you to save time and hassle while focusing on what you do best (which isn’t billing).
For sole proprietors, this can make a huge difference in your ability to compete for work, land new projects or clients, and complete them. Imagine how much more you could do if you didn’t need to worry about billing your clients.
Now, with all that being said, it is important to realise that most factoring companies will take over all billing for the client whose invoice(s) you sold, and will also alert your client that they now need to remit the amount owed to the factoring company, rather than to your business. If you need more discretion, you can find some companies that offer non-notification factoring, but the fees are often higher in this sort of situation.
Most businesses today are aware of factoring and the benefits it offers, and will not take it as a sign that your company is floundering, so discretion might not be as necessary as you think.
What Types of Invoices Can I Sell?
It’s important to understand that factoring invoicing is only workable with specific types of invoices. If you don’t bill your clients on a net 30, net 60 or net 90 day basis, then you will not be able to work with a factoring company. In fact, there’s actually little point.
The entire benefit of selling your invoices is to get access to capital sooner than your clients would have normally paid, so if your invoices are due on receipt, then you would see no benefits from selling them in the first place.
Also, it’s worth noting that factoring companies are not collections agencies, although they handle collections in conjunction with normal billing. That means you cannot sell them invoices on delinquent clients. If your client has not paid, and they are substantially past due, you’ll need to work with an actual collections agency instead of a factoring company.
How Much Money Will I Receive?
This is one of the most frequently asked questions concerning factoring invoicing. Sadly, there is no one-size-fits-all answer. Really, it depends on a couple of different factors. One of those is the amount of the invoice in question. The other is the advance policy of the factoring company you’re working with.
As a general rule, most factors will advance you between 70 and 90% of the invoice total, although there are some firms that will advance up to 95 or even 98% of the total. Obviously, that’s a big jump from 70 to 98%, so it’s in your best interests to ensure that you’re working with a company that will advance you enough of the total that you can meet your needs.
There’s little point in working with a firm that will only advance you 70% if you need 85 or 90% to meet your cash flow requirements.
How Much Will I Pay for Factoring Invoicing?
This is another question with the answer of “it depends”. There are two considerations that will determine the amount of the factoring fee that you’ll pay. One of those is the invoice amount, and the other is the policy of the company.
Most companies charge a factoring fee that ranges from 1% to 5% of your invoice total. This should be evaluated before you sign a contract with a company. However, you should also understand that in the world of invoice factoring, you will never see 100% of the money that you’re due from a client or customer.
The factoring fee charged will eat into that, as will any other fees or charges assessed by the company (application fees, processing fees, account maintenance fees, handling fees, etc.). So, if you do need all of the money owed to you in order to make a profit, factoring may not be a good fit.
How Much Does the Factoring Company Know about My Industry?
When you start to look at factoring invoicing companies out there, you’ll quickly find there are two broad categories into which they fall. There are generalists, which are factoring companies that will work with just about any client in any industry.
There are also specialists, which gear their services to clients within a specific industry or niche. Examples of specialisations include trucking/logistics, warehousing, retail, manufacturing and more.
Which is right for your needs? For most companies, a specialist factoring firm will be the better fit. There are quite a few reasons for this, but the most important of them is this: a specialist factoring company understands how your industry works.
A generalist will be unlikely to know the details surrounding invoicing and billing norms within many industries, and might not be willing to take what they perceive as a risk, when it’s actually “business as usual”. Or, if they do take a chance, they might charge much higher fees than a company that’s familiar with your industry would charge.
How Fast Can I Get Cash?
This is yet another area in which factoring invoicing is better than going through a conventional lender. When you apply for a loan or a line of credit, it may take 30 or even 60 days to process and have the funds available to you. With invoice factoring, you should have your money within 24 to 48 hours at the most. Once you have that cash in hand, you can use it for whatever you need, including:
- Making payroll
- Paying vendors and suppliers
- Purchasing more supplies to take on new clients
- Investing in business growth opportunities, such as new equipment or new property
Do I Repay the Advance?
No, there is nothing to repay when you use invoice factoring. That money is yours, free and clear. The only charge should be the factoring fee (although some companies do assess other fees, so read your contract closely before signing). Once you’ve obtained your advance, you can spend it as you wish, and then benefit from receiving the remainder of the balance when your client pays the invoice.
What If My Client Doesn’t Pay?
The results of a non-paying client will vary depending on whether you’re using recourse factoring or nonrecourse factoring. Recourse factoring means that if the client doesn’t pay, you’re responsible and will need to repay the advance to the factoring company. Nonrecourse factoring means that the factoring firm is responsible if your client doesn’t pay. However, nonrecourse factoring is usually more expensive than recourse factoring, so that should play a role in your decision to use a particular factoring firm.
Now that you have a better understanding of factoring invoicing overall, it should be clear just how beneficial this financial tool can be for your business. Of course, you cannot take advantage of it on your own – you’ll need to work with a factoring company, and finding the right one can be difficult, particularly if you’re pressed for time due to the need to run your business, or unsure of what qualities to look for in such a partner. In the next section, we’ll discuss how to choose a factoring company.
How Do You Choose the Best Factoring Invoicing Company?
Choosing the right partner from the many available in Canada can be a daunting task, but it is essential that you take your time and vet your options thoroughly. Start by determining your needs.
Do you need to sell just one invoice (spot factoring) or would you benefit from a long-term arrangement in which you sell all invoices from a particular client moving forward? Would you benefit from perks, such as discount fuel cards, or the ability to outsource back-office services?
Once you’ve determined your needs, you’ll need to compare factors out there. This should be done on a side-by-side basis. Compare several factors to narrow down your options until you have only a few, and then conduct interviews with each. Study the contract offered by each company closely and make sure to read the fine print thoroughly to avoid encountering unexpected fees and charges.
Keep a close eye out for things like hidden fees and additional charges that can create mounting costs that eat into the capital you ultimately receive. Finally, choose the company that offers the best mix of features and benefits.
If you’re not sure how to move forward, but are convinced that factoring has a great deal to offer your business, we can help. We invite you to take advantage of a free consultation with one of our factoring invoicing specialists who will help you not only determine what your business needs, but connect you with the right factoring companies.