Invoice Factoring for Small Businesses
A better way to fund your growth
Invoice Factoring for Small Businesses
A better way to fund your growth
Table Of Contents
What is Invoice Factoring?
If you are a business that invoices your clients and customers instead of collecting payment up front, you have probably experienced the frustrations of waiting for a client to pay on their invoice. This waiting period can cause your business to see uneven cash flows and long payment cycles. This can be detrimental to a business, especially one trying to grow.
In fact, a 2017 study by Business Insider finds that the number one reason businesses fail is due to cash flow problems. Steady cash flow will allow your business to the freedom to do things such as:
- Make Payroll
- Purchase New Equipment
- Invest in Marketing and Advertising
- Hire more staff
- Buy new equipment
- Pay rent and recurring bills
- Collect funds faster
What Are the Different Methods of Solving Cash Flow Challenges?
You can solve your company’s cash flow challenge through a number of different methods.
- Invoice Factoring
- Secured Bank Credit / Loan
- Credit Card
- Unsecured Line of Credit
While there are pros and cons to each available option, most can be time-consuming and costly. Invoice factoring provides your business with the means to quickly obtain the cash needed to run a successful business while maintaining a lower upfront cost.
For more information on this topic, see Why Should I Factor My Invoices?
How Does Invoice Factoring Work?
Invoice factoring occurs when a business sells its invoices to a factoring company. The factoring company will pay 75-95% of the invoice value and will collect the payment directly from your customers.
Factoring is not a loan; it is an agreement to sell your invoices at a discounted rate with the factoring company assuming the credit risk for the purchased invoices. Because of this, the requirements and qualifications for invoice factoring are much different than a traditional bank loan or a line of credit. This makes invoice factoring a beneficial choice for many businesses, especially new, small, or growing businesses or ones who may have from poor credit.
Why Choose Factoring Over Financing?
Invoice factoring and accounts receivable financing are often discussed as interchangeable options for increasing your business cash flow. However, financing is not the same as invoice factoring.
When you choose accounts receivable financing for your funding option, you are choosing a revolving loan as a method to solving cash flow issues. This loan is issued based on many different factors including your company or company officer’s net worth, assets, and credit.
Invoice factoring, on the other hand, is not a loan; it is simply the sale of your invoice which reduces your accounts receivable by the amount of the sale and increases cash. Factoring is a better option for new or growing businesses because qualifications are not based on net worth, assets, or credit checks on the company or officers.
For more information on this topic, see What’s the Difference Between Invoice Factoring and Accounts Receivable Financing?
How to Choose a Factoring Company
Invoice Factoring may be the best choice for your company, but not all invoice factoring companies will work for you. It is important that you not only take the time to research invoice factoring, but also your invoice factoring company before signing a contract.
Some areas to take a look at when choosing an invoice factoring company include:
- Fee Structure
- Approval Methods
- Client Protection
- Funding Timing
- Company Culture
- Company Rates
It is important to consider all this and more when choosing a factor to work with. They will reflect on you and your business, so be sure to take the time to make sure you choose one that is the best fit for you.
For more information on this topic, see How Do I Choose an Invoice Factoring Company?
Is Factoring a Good Choice for a New Business?
One of the main struggles a new business faces is that it is difficult to obtain funding due to poor or nonexistent credit. Even if a new business does have good credit, banks and other financial institutions rarely will give them an opportunity for funding due to lack of history and assets.
Factoring, however, has different criteria for acceptance than a traditional loan or line of credit, which makes it a good choice for not only established businesses, but also ones that are just starting out.
For more information on this topic, see Is Factoring a Good Choice for a New Business?
What are the Typical Business Requirements Needed for Invoice Factoring?
While qualifications for invoice factoring are much different than a traditional loan or line of credit, there are still a few requirements businesses must meet to be accepted by a factoring company.
These requirements typically include:
- Business references
- Company documentation
- Clean background check and no pending legal matters
- No outstanding security risks
Since factoring approval is not based on personal credit or company credit, factors have to ensure that businesses are who they say they are and will be able to provide the correct paperwork for invoice funding. If a business meets these requirements, they should be approved to factor.
How to Get Started with a Factoring Company
Once you have decided to factor your invoices and chosen a factoring company, you can begin the process of approval and factoring. Typically, there are four steps to get started with your chosen factoring company.
- Fill out an application and provide all necessary documentation
- Provide business references
- Background and customer credit checks
- Underwriting and contract approval
After you have completed these steps and signed your contract, you are ready to begin factoring any new invoices!
For more information on this topic, see Steps to Take to Get Started With a Factoring Company
Does My Credit Impact My Factoring Approval?
Most factoring companies look for three requirements when determining if they will accept a business as their client for invoice factoring:
- Your business’ accounts receivable must be free of any liens or contingencies
- Your customer must be creditworthy and capable of paying invoices within terms
- You must have documentation proving services rendered or product received and accepted
Factors are trying to determine if your customers will be able to pay the invoices you factor. Typically, your own credit as a business does not come into play for this requirement. This is why invoice factoring is a beneficial option, especially for companies who have poor credit or are working on building up their credit.
For more information on this topic, see Does My Credit Impact My Factoring Approval?
What Happens If My Customer Doesn’t Pay?
When a factoring company purchases an invoice, it is with the understanding that the customer will pay the invoice according to terms. The factor provides a percentage of the funds up front to you in cash and receives their payment when the customer pays the invoice in full. However, if a customer doesn’t pay their invoice according to terms, what happens?
Typically, if a customer refuses or can’t pay their invoice, a factor will begin by making collection calls themselves to the customer. If this doesn’t produce results, the factor will then send formal demand letters. Finally, depending on the type of account you have and the factoring company you are working with, the factor will either require payment from the client or they will be forced to send the account to a collection agency.
For more information on this topic, see What Happens If My Customer Doesn’t Pay Their Invoices?
Will Customers Know When Their Invoices Are Factored?
When you factor your invoices, you are selling your customer’s new invoices to your factor. However, just because a factor is becoming involved with a customer’s invoice does not mean that it will become an inconvenience.
A factor will let the customer know that their invoice has been purchased by what is called a Notice of Assignment. This lets the customer know that instead of paying you they will instead pay the factoring company. No other processes must be changed and this is designed to make the transition as smooth as possible for the customer, the client, and the factor.
For more information on this topic, see Will Customers Know When Their Invoices Are Factored?
Can I Choose Which Invoices to Factor?
As you begin factoring your invoices, you may begin to realize that you don’t want to factor every single invoice or you only want to factor certain customer accounts. If so, is invoice factoring still your best option?
While many factors will compel their clients to submit all of their customers’ invoices for factoring, other companies, like UC Factors, believe that a client should be able to choose which invoices to factor.
Customers must still be approved before their invoices can be factored and factors may also require a factoring minimum, either on a monthly or annual basis. However, it is important that if it is important to you to not factor every invoice, that you work with a company who abides by that policy.
For more information on this topic, see Can I Choose Which Invoices to Factor?
How Do Factoring Companies Get Paid?
Factoring companies get paid when your customer pays their invoice. When you factor your customers’ invoices with a factoring company, you are selling them that account. The factor will give you cash up front for a percentage of the total amount of the invoice, usually 75-95%.
When your customer pays their invoice, they pay the full amount to the factoring company. When this happens, the factor gets the amount they advanced to you back plus the additional percentage as their factoring payment.
Recourse vs. Non-Recourse Factoring
When you begin your business relationship with a factoring company, you will typically be looking at two different types of accounts, called a full recourse account and a non-recourse account. For the most part, the factor will determine which type of account you will have.
Full recourse accounts are the more common of the two. A full recourse account meads that you, the client, is ultimately responsible for the amount of your customer’s invoice in case they do not pay.
Non-recourse accounts are less common because they place more risk on the factor. With a non-recourse account, the factor is solely responsible for the credit of the customer and if the customer is unable to pay for credit insolvency reasons, the client will not be held responsible for payment.
For more information on this topic, see What’s the Difference Between Recourse and Non-Recourse Factoring?
What Are Some Hidden Factoring Fees to Look Out For?
One of the most important things to be aware of when signing a contract with a factoring company is their fee structure. Often times, factors will lure uninformed businesses into agreements at a low rate. However, the factor adds hidden fees into the contract, including:
- Same Day Funding
- Credit Checking
- Fee Per Invoice
- Non-Factored Fees
Before you enter into a contract with a factoring company, make sure you will not be subject to any of these hidden fees. Remember, as with most things, you get what you pay for; if the initial price for a factoring company seems too good to be true, you could end up paying more in the long run due to undisclosed fees or charges hidden in the fine print.
How Soon Will I Get Paid?
Once you’ve been approved to factor your invoices, you are all set to begin receiving funding! To get paid, submit your invoice(s) to your factoring company along with all the proper documentation (bill of sale form, proof of service, etc.).
The factoring company will then:
- Check approved credit on your customer
- Make sure the invoice is billed properly
- Make sure all information provided is correct and matches customer records
- Process and fund the invoice
As long as all your paperwork is in order and present, at UC Factors we are typically able to process it and fund our client the same day!
Factoring is a Great Solution for Growing Businesses
Whether you are in the transportation industry, the retail industry, the manufacturing industry, or many other areas of interest, you can benefit from invoice factoring! At UC Factors, we have an experienced staff who are well versed in a variety of industries. Not only are we experts at factoring, but we can also help you with industry-specific billing and payment procedures.
Our management has been in the business between 28 to 42 years and the majority of our staff has been with us for 15 to 20 years. This has allowed us to develop a level of expertise and knowledge of how factoring is specifically beneficial to numerous industries and companies.
When you work with an experience factoring company, you will have a financial partner who understands your industry and protocols and uses that knowledge to help grow and develop your business with the freedom granted by invoice factoring and access to cash flow.