Starting up a business or running a small company is no easy task. More often than not, having a good business model alone, while essential, isn’t quite enough to overcome the ever-increasing competitive market that most industries consist of today. To this end, it’s not just a mere luxury to have the right financial solutions at your disposal but an absolute necessity for both the growth and survival of the business. This where invoice factoring comes into play.
As a financial option, invoice factoring serves the purpose of allowing more flexibility in resources for a startup company to chase new and potentially lucrative ventures as well as help struggling businesses make ends meet with invoicing and payment gaps. While larger companies with more resources can usually settle for invoice discounting, invoice factoring rates can make all the difference for a smaller one in desperate need of a financial boost. With all the advantages and benefits that it yields in serving as a short-term remedy for cash flow issues, it’s still crucial to have a certain degree of familiarity with how factoring works, its methodology and rates before pursuing this option.
How invoice factoring works
It starts with invoicing customers or clients to which you have provided products or rendered services for. There are certain requirements in order to qualify for this financial option, but the length of time in which they must be payable shouldn’t go past 90 days. The time frame allotted makes it reasonable and maximizes the possibility for the aforementioned payment to be made without incurring any issues.
It is at this point that the business will then apply to a factoring agency or provider and sell the outstanding invoices to the factor or the chosen company that will be providing the financial service of invoice factoring. There are a number of elements that will be considered before a factoring agreement can be reached. The criteria, which oftentimes entail the credit risks of the customers, will determine whether the financial agreement can be made as well as the maximum amount that can be borrowed.
An advance is then given by the factor, the rate of which is commonly around 80 percent of invoice’s determined value. The key elements that will dictate this advance will ultimately be the size, the business and industry and other parameters related to risk. Payment will then be made by the respective client and the remaining balance of the invoice is then directed back to the business with the fees of the service already taken.
Determining the cost and rate
Like any other service, invoice factoring comes with a price. While different companies will have equally different base costs, they commonly involve, if not depend primarily on, the factor or discount rate as well as the duration or length of time over which payments by the customers will be made. The former can be charged either on a monthly basis or weekly basis, depending on the agreement made between the business and the factor. The generally accepted industry range usually starts from .5% to approximately 5% of the total invoice value.
Other fees to consider
Invoice factoring may serve as an important financial safety net that can determine the success or failure of a company, it’s important not to overlook the additional expenditure that this service entails. It isn’t uncommon for factors to have certain fees included apart from the base price, from the upfront costs, which could easily reach $1,000 to incremental fees that may potentially be charged in certain cases.
The most substantial fee that no business can ill-afford to overlook is the overdue or collection fee. While not all factors have this included in their agreements, some may certainly charge a certain amount when payments from customers go past their due date. The cost varies, and ranges from non-existent to a small fortune that can easily put a dent in the bank account of a business, if not break it completely.
Additional expenditure can make or break a small business. Because of this, it becomes good common practice to ensure that you have a breakdown of the factor’s fees and review the contract thoroughly before making any agreements or trying such a service. This will not only give you a better idea of what all the fees are, but it will also help save money by comparing the multitude of factors available, and selecting the one offering the most beneficial terms according to the circumstances of your business.
Apart from the fees and costs, it is important to be familiar with the different kinds of invoice factoring. The two most common factoring methodologies involve what is called the recourse and non-recourse methods. In a nutshell, recourse factoring involves the factor collecting the payment directly from your business if a customer is unable to pay the amount on the invoice at the allotted time, while the latter is the exact opposite. It may be common sense to opt for the non-recourse option if possible, but there are a few advantages to selecting the recourse option as well.
It terms of commitment, there’s also spot or contract factoring to consider. While the former in this case may be more appealing to the business or client because of the flexibility it offers, most factors prefer the contractual counterpart. The main reason for this is that the companies giving the service don’t earn as much profit from single invoices as opposed to the minimum amount required every month with contract factoring.
There may be plenty of different financial options available, but for consistency and a quick, straightforward approach you’ll be hard-pressed to find something better than invoice factoring. It allows you to be in constant communication with the factor to discuss elements pertaining to the agreement, deals and transactions. It also helps that it relies far more heavily on your own clients or customers’ credit scores rather than your own. Invoice factoring also serves as a remedy for the typical requirements that a more traditional lending system approach usually entails.