Thanks to Deedster on Pixabay for the featured image.
Are you making sales but struggling to pay your business expenses because your hard-earned money is stuck in unpaid invoices instead of cold hard cash? If you own a B2B or B2G company and your cash flow or growth is suffering because you have to wait weeks or even months for your customers to pay, then invoice factoring might be what you need.
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What Is Factoring?
With invoice factoring, you can get business funding by selling your outstanding invoices to a factoring company (aka the factor). The factor gives you a cash advance, which is usually 70%-90% of the invoice value. They hold the remaining amount as reserve.
When your customer pays the invoice, the factor deducts a factoring fee and a processing fee from the reserve then gives the remainder to you. The processing fee is usually around 3% while the factoring fee is a certain percentage of the invoice value, computed on a weekly or monthly basis.
Here’s an Example
Let’s say you have an invoice worth $50,000 and you expect it to be paid after four weeks. If the factoring company advances 85% and charges a 3% processing fee and a 1% weekly factoring fee, this means you immediately get $42,500 (85% of $50,000) as a cash advance. The factor would hold the remaining $7,500 as reserve.
Now once your customer pays the invoice four weeks later, the factoring company will take out its $1,500 processing fee (3% of $50,000) and its $2,000 factoring fee (1% of $50,000 x 4 weeks) from the reserve. Then they would give you the remaining $4,000. All in all, you will get $46,500 from your invoice value of $50,000.
Many Entrepreneurs Don’t Know About Factoring
While most—if not all—entrepreneurs know about bank loans, only a few know about invoice factoring. This is a shame because this form of financing can easily and quickly free up capital that you can flexibly use for your day-to-day business expenses. Or you can use that cash to grab opportunities for moving your business forward.
It’s Easy to Qualify
Unlike bank loans and other types of traditional business funding, it is easy to qualify for invoice factoring. That’s because the invoices act as your collateral. Application and approval are both speedy. As a matter of fact, you get the advance in just one or two business days after being approved.
Also, there is less stress for you because you are not taking on debt. As long as your customers are creditworthy (such as established businesses or government agencies), you do not have to worry about paying back the advance. That’s because you have already made the sales and are just waiting for the payment. Instead, you can use your mental energy to focus on ways to grow your business or to make your business workflows smoother.
How You Can Use Those Freed-Up Funds
Some of the things you can use the funds on:
- Marketing and advertising
- Paying for unexpected expenses
- Upgrading equipment
- Purchasing in bulk to get steeper discounts
- Paying debt to avoid penalties
- Hiring more workers
- Increasing output to meet seasonal demands
- Paying regular expenses such as payroll, utilities, and rent
What Is the Difference Between Invoice Factoring and Invoice Financing?
Some factoring companies also collect the payment on your behalf. Therefore, if collection is a process you would rather outsource to improve efficiency or lower overhead costs, invoice factoring can also help you with that. Just note that there is a funding option very similar to invoice factoring called invoice financing, which does not take care of collection. But many companies use the terms “invoice factoring” and “invoice financing” interchangeably.
Therefore, before signing an agreement, make sure to clarify with the factoring company if they would be collecting payments or communicating with your customers.
The Bottom Line
Invoice factoring is a fast and easy way to get additional capital. You can use these funds to accelerate the growth of your company or solve any cash flow issue. The fees may be higher than with traditional lenders, but its flexibility, speed, and low risk can help your business stay afloat and grow while you wait for your customers to pay.