Have you ever wondered how invoice factoring can benefit your day-to-day operations? If so, you'll be glad to know that various types of businesses leverage the factoring process to reduce operating overheads and improve cash flow. As a result, your company's future becomes brighter thanks to more affordable loans than traditional bank financing options.
Many companies enlist the assistance of invoice factoring service providers when faced with revenue constraints. With factoring, it's easier to cover financing gaps by selling unpaid invoices to an invoice factoring company. This approach provides immediate access to much-needed working capital.
In this article, you'll learn how invoice factoring works and discover ways to determine its suitability for your company. You'll also learn about a more convenient and faster way to generate invoices using Skynova's business templates.
What Is Invoice Factoring?
Invoice factoring is a financing option that allows you to sell accounts receivables via an invoice financing company. The factoring firm takes over the outstanding invoices after verifying the client's payment history and credit score. During the transaction, you transfer the invoices for a small fee to the factoring firm.
If you sign a recourse invoice factoring agreement, the advance rate can be 100% of the invoice amount. The transaction allows you to mitigate late payments and deal with your company's cash flow problems. On the other hand, a business factoring contract may advance at least 95% of the value of the invoice. With a non-recourse factoring agreement, you can get your hands on immediate cash at a rate of between 90% and 97%.
Once the client pays the outstanding amount, the factoring company deposits the remaining balance via ACH, minus a fee, in your company's business bank account. The transaction eliminates the need to wait between 30 and 120 days to receive payment from clients. In turn, you can resolve financing needs in a timely manner to keep your business running smoothly.
Factoring companies typically approve and remit the cash advance within a day or two, allowing you to focus on growing your business. It's no surprise that receivable factoring is becoming increasingly popular with small businesses. Depending on your circumstances, it can be a viable form of financing. Factoring companies are usually happy to take over the collection responsibility if your customers pass a creditworthiness check.
How Invoice Factoring Works
Many factoring companies remit the invoice amount in two installments, with the first payment coming immediately after signing an agreement. The follow-up payment excludes the factoring fee.
Once you choose a factoring company, you submit the relevant invoice details. In turn, the service provider conducts due diligence (credit checks) regarding the clients involved. This step is crucial to mitigate credit risk. If the client passes the assessment, you receive an advance rate quote for the transaction.
You can compare the quote with offers from other factoring companies to determine the best rate. If you're happy with the quote, you can sign the contract and wait for the factoring service provider to make the first payment. With the invoice amount in your bank account, you're free to use the funds to cover strategic business needs. At the same time, the factoring company activates collection procedures with the clients.
You can expect to receive the remaining balance, excluding the fee, after the clients pay via the factoring company. This type of service makes it easier to cover operating expenses, such as staff salaries and supplier bills. Counteracting cash flow problems through invoice factoring is vital to the survival of your business.
All in all, invoice factoring helps you get paid faster and simplifies accounting processes. You can also bolster your billing processes by investing in Skynova's invoice template, which comes with wide-ranging features like invoice management, online payment, tracking, and unlimited storage.
Why Use Invoice Factoring?
One of the main reasons to use invoice factoring is accessing funding without approaching traditional lenders. Many small businesses with an imperfect credit history struggle to find lenders willing to provide business financing.
Receivable financing undoubtedly adds value by providing a viable alternative to overdrafts and business credit. Therefore, factoring reduces the cost of business financing, which improves invoice payment processes in the long term.
How to Choose an Invoice Factoring Company
Signing a long-term contract with a factoring company is a practical way to improve cash flow. To maximize the benefits of invoice financing, though, you need to choose the right factoring company that offers invoice discounting deals (such as a discount rate).
The market is awash with factoring service providers, and you should know how to compare their invoice financial deals. It's vital to match the right company with your specific financing needs.
Key factors to consider include:
- Hidden fees
- The availability of non-recourse factoring
- Free credit checks
- Upfront advance rate
- Processing time
- The range of invoice factoring services
When comparing factoring companies, check for hidden fees. One of the most common hidden fees involves creditworthiness checks. Some factoring businesses hide the charges for verifying the credit history of your clients. Always scrutinize the fine print of invoice factoring agreements before signing any contracts. The ideal factoring company offers free credit checks, helping you retain most of the invoice amount.
Another critical aspect to consider is whether a service provider offers non-recourse factoring — if a customer fails to pay the invoice, the factoring company absorbs the losses associated with the transaction. This approach can save your business a significant amount of money.
The ideal factoring company should also offer additional services, such as spot factoring. With this type of factoring, the service provider allows you to factor in a single invoice at a time irrespective of the amount involved. Spot factoring is beneficial to small businesses with fewer customers.
Is Invoice Factoring Right for Your Small Business?
Invoice factoring might be beneficial to some small businesses more than others. For this reason, assess the benefits of this type of business financing to your venture. Once you identify compelling reasons to factor in your invoices, you need to find the right service provider.
Factoring is the right option if your company has many unpaid invoices and lengthy payment terms of between 30 and 120 business days. By factoring in the invoices, you can limit how long cash flow problems affect your operations.
Invoice financing is a prudent move if your company's credit record is poor. You can circumvent traditional lenders by enlisting the help of established invoice factors. You can also opt for invoice financing if your business doesn't have a credit record or if you've got a low personal credit score.
Another critical aspect to consider is whether you can afford the fees. Factoring companies typically charge a fee of between 1% and 5% of the invoice amount. Some companies charge additional fees, such as monthly minimums, money transfer fees, renewal charges, and servicing fees.
Manage Business Finances More Effectively With Skynova
Cash flow problems and inefficient accounting processes contribute to the failure of many small businesses. To grow your venture sustainably, you need to bill your customers or clients effectively. Likewise, you must maintain financial records using thorough accounting systems. In doing so, you can boost your company's financial health and long-term growth potential.
Skynova provides business solutions capable of enhancing your ability to bill clients effectively, track payments, and record various types of transactions. From generating professional invoices to sending quotes, you can count on our software to streamline core business processes.
To discover more business solutions to improve your billing and other functions, explore our software products today.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting accounting standards.