Invoice factoring gives you the opportunity to immediately receive payment for outstanding invoices. However, many drivers worry that having less than exceptional credit will prevent them from taking advantage of factoring services.
Fortunately, this is not the case. While factoring companies will conduct a credit check, it does not directly impact your eligibility for invoice factoring. Here’s everything you need to know about factoring and the role your credit plays in the factoring process.
As one of the industry leaders, TAFS assists trucking companies to increase cash flow with factoring rates as low as 2.49%, business loans and 1-Hour Advance options.
How does invoice factoring work?
Many companies struggle to collect payments on their invoices. Factoring invoices helps companies receive immediate payments on their invoices.
An invoice factoring company will pay money for your invoice. They will collect invoice payments from your clients, and you will have access to immediate funds.
Does your credit score matter?
Your credit score does not determine if you qualify for invoice factoring. Low-credit businesses often reach out to a factoring company so they can quickly receive access to funds. Instead of looking at your credit score, invoice factoring companies look at your accounts receivable. They use this data to determine what to offer for your invoice.
Will invoice factoring companies do a credit check?
A factoring company will still conduct a credit check. The credit check helps them assess their risk. Companies will use your credit score to determine how much risk they wish to incur in your business. If your credit score is low, they may charge a slightly higher factoring rate.
Will factoring affect your credit?
The good news is that invoice factoring will not affect your credit because this process does not increase your debt. Instead, you receive immediate cash flow from your invoice instead of waiting until the end of the invoice’s term. You also don’t have to chase clients who don’t pay their invoices promptly.
How do you qualify?
Before factoring invoices, companies will check if your business qualifies for it. Make sure you meet these qualifications before approaching a factoring company:
- You operate a business
- Have commercial or government clients
- Clients have good credit
- No open bankruptcy
- Profit margin qualifications in the 10%-15% range
- No liens or encumbrances on invoices
- Basic company information provided
- Have an established payment plan for tax problems or tax liens
- Credible background
As long as you meet these requirements, you should have no issues factoring your invoices.
What determines the factoring fee?
Invoice factoring companies charge a fee. This fee is the company’s profit from factoring your invoices. Companies will assess the creditworthiness of your business and the invoiced client when determining the amount.
Factoring companies will also consider the average days outstanding in receivables. If the company feels confident in receiving the full invoice over time, they will charge a lower fee.
Example of invoice factoring
Let’s say you issued a $10,000 invoice to one of your clients. This client will pay the invoice within six months. However, you need the money now to buy new equipment. Unfortunately, your credit is low, and banks won’t give you a loan.
You can’t ask the client to pay the invoice immediately. However, you can turn to a factoring company. It will give you upfront money in exchange for the invoice payments.
Suppose a company gives you $9,300 for your $10,000 invoice. You immediately receive the $9,300 and can use that money to fund new equipment. You missed out on an extra $700, but you needed the money. In this example, invoice factoring was right for the business. The company collects invoices from your client. If they collect all of the proceeds, they end up with $10,000. Those proceeds represent a 7.53% gain from the company’s $9,300 investment.
Factors to consider when factoring with bad credit
Some businesses can benefit from factoring. It gives them access to funds even if they have bad credit. However, invoice factoring is not perfect. Consider these factors before obtaining factoring funds.
Credit
Invoice factoring companies will review your clients’ credit scores before factoring an invoice. In some cases, low credit scores can affect your ability to qualify and increase factoring fees.
Customer reliability
Companies will look at your accounts receivable to measure customer reliability. They want to ensure a client can pay the invoice. They will look at your invoice payment history to see if your clients pay up. The less reliable your clients are, the higher your fees.
Invoice payments
If you have a working relationship with the client, invoice factoring companies will analyze it. They want to see if your client reliably pays the invoice on time. A late-paying client will increase the company’s risk. This increased risk will result in higher fees.
You may want to choose a recourse contract for factoring invoices. These contracts let you buy back unpaid invoices to reduce your fees.
Cost
Invoice factoring can get expensive. Many companies charge between 1%-5% of the total invoice amount in service fees. These fees will bite into your profits, but you get immediate access to funds.
Advantages
Many companies use invoice factoring to raise cash quickly. They do not have to turn to traditional banks for funds. These banks will charge higher interest rates for low-credit businesses. Some low-credit companies may not qualify for a bank loan.
Since you sold the invoice, you don’t have to haggle with clients about paying on time either. That burden falls to the company, as they purchased the invoice and the rights to communicate with the client.
Disadvantages
Invoice factoring companies will take a fee from your invoice. Even though you gain money in the short term, you lose money over the long term. Factoring companies have longer time windows to collect proceeds.
An invoice factoring company can ruin the relationship between you and a client. If the company is overbearing about collecting payments, your client may do business elsewhere. Therefore, you should make sure you select a company that will not pressure your clients or make them feel uncomfortable.
Invoice factoring vs. invoice financing
During invoice factoring, a company sells its invoice to an invoice factoring company. You no longer own the invoice, but you receive quick cash.
During invoice financing, you borrow money against your unpaid invoice. You are still responsible for collecting payments and reaching out to clients. You will pay interest and fees for invoice financing. If you fail to repay an invoice financing loan within the specified timeframe, this debt will negatively impact your credit as well.
Choosing an invoice factoring company
Factoring payments may sound like an appealing opportunity, especially if some of your clients are known for dragging their feet when it comes time to pay invoices. However, if you partner with the wrong factoring services provider, you could end up sacrificing far too much of your profits and inhibit business growth.
That’s why we recommend doing some more research on invoice factoring before making your final decision. Check out “What is invoice factoring?” — our introductory guide. Then, take a look at our recourse vs. nonrecourse comparison so you can find the service provider that is the best match for your business.
Once you are done, you can confidently navigate the process of finding a factoring company to help your business thrive.
FAQ
Factoring companies perform credit checks to assess your reliability. They typically check your business’s credit history, not your personal score. However, they could check both.
The factoring company might deny you if you don’t process a large volume of invoices or you don’t agree to their rates.
No, because the factoring company is purchasing the rights to your invoice. They are not technically loaning you money, even though a recourse factoring company could request a refund if your client defaults on the invoice.
