Small business factoring can be an absolute lifesaver for some businesses, enabling a business to immediately monetize their sales and turn them into virtually instant cash flow and profit. It isn’t for everyone, though: As noted by the financial experts at Lantern Credit, “Factoring companies will pay you a percentage of the invoice amount upfront, which reflects the advance rate…Once the factoring company receives full payment from your customers, they provide you with the remaining amount of the invoice, minus a factoring fee.” This means that yes, you get instant payment, but you don’t get everything, and you will lose a factoring fee.
What is Invoice Factoring?
Here’s how Invoice Factoring works. Let’s say you run an office supply business and make a sale of $100 in pens. You invoice the company in question, which may pay you in 90 days. In that time, your bills build up, and you may wind up needing to use a credit card in order to pay off other costs. If you had received payment for that $100 upfront, this wouldn’t be a problem.
With invoice factoring, you turn the invoice over to a vendor, known as a Factor. They will give you a certain percentage of the costs immediately and then be responsible for the collection of the invoice. The percentage they pay you up-front typically ranges, depending on the rates you negotiate with them and the risk of your industry. Once the invoice is paid, you will receive the rest of the cost, minutes the factoring fee.
So, what does this mean for your business? You get a large chunk of an invoice paid immediately and then don’t have to worry about the collections – that is handled by the Factor. Even if they never pay the invoice, you are still able to receive a chunk of the payment, and once they do pay the bill, you receive much of the rest.
However, you will lose a percentage of every sale you make as part of the Factoring fee, and your accounts receivables are now completely out of your control. In industries with tight profit margins, this can be highly problematic.
What is it used for?
Invoice factoring works best for small businesses that have cash flow troubles since it allows you to automatically turn your accounts receivable into partial cash. It can also save you time and effort, as you no longer have to chase down accounts that owe you money. Of course, there is a real cost associated here: A factor can take a good bite out of your profits. So find the best invoice factoring companies to invoice factoring calculator.
At the end of the day, factoring can be very helpful for multiple types of businesses, but there is no doubt that it isn’t for everyone, and typically works better for smaller businesses that need immediate payment on their invoices. Before contracting with any factoring vendor, make sure to do your homework and make a determination about whether or not factoring makes financial sense for you.