Cash flow is an essential part of any business. But, sometimes, you might have too many outstanding invoices and not enough money in the bank to pay your financial obligations. When that happens, you can turn to options outside of traditional financing agreements.
Invoice factoring is the process of selling outstanding invoices to an invoice factoring company for a small percentage. You’ll get anywhere from 80% to 90% of the invoice value within 24 to 48 hours, which you can use to fund your business.
Keep reading to learn more about what invoice factoring is, how you can use it in your business, and important things to know before working with any companies.
How Does Invoice Factoring Work?
Invoice factoring is a process that allows you to sell invoices in exchange for a payment. That payment is usually equivalent to the majority of the total invoice value. This makes it possible for you to fund your operations quickly. The process is fairly simple.
- You enter an agreement with a customer to provide goods or services.
- You issue an invoice for those goods and services.
- You present the invoice to a company for review. If the company finds that the invoice is valid, they’ll likely proceed.
- You sell those invoices to an invoice factoring company, which pays you for the majority of your invoice, which is generally upwards of 90% of the total invoices.
- The invoice factoring company now owns and manages the invoice so they’ll track down payment from your customer.
- The customer pays the company directly.
- Upon collecting the full invoice amount from the customer, the company will pay you the remainder after the advance, minus the company’s fee.
Why is Invoice Factoring Important?
Invoice factoring can help you quickly reinvest your income back into your business. That way, you can pay for equipment, employee or contractor wages, loans, and more, seeing as this accounts receivable method is important. It can ensure that you infuse your business with the cash flow you need to avoid service disruptions. It provides a solution to the alternative of taking out a loan to pay your day-to-day expenses or having to let go of employees who you wouldn’t otherwise be able to pay.
Is Invoice Factoring A Debt?
No, this is not considered a debt. You essentially sell the rights to a third party, and that third party commits to tracking down the money that the customers initially owed to you but now owe to the company directly.
How Much Does It Cost To Factor an Invoice?
The total cost varies as it depends on your sales volume, the total invoice amount, the customer’s credit, and whether the factor is categorized as recourse or non-recourse. Companies use these factors to determine a total rate anywhere from 1% to 5% of the invoice, and it’s based on the amount of risk the company will have to take on when purchasing your invoice.
When Should You Use Invoice Factoring?
You should use invoice factoring when you have a lot of outstanding invoices or if your cash flow is greatly impacted by those outstanding invoices and you need a cash infusion to continue operating your business.
Is Invoice Factoring Lending?
No, invoice factoring is not a form of lending because you are selling the rights to collect money on a valid invoice. That means that the invoice factoring company is getting something of equal value for the money being advanced to you.
Example of Invoice Factoring
Let’s say you have an invoice for $10,000 from a shipping company whose goods you hauled. The invoice has a 60-day payment term, meaning you might not get that money for almost two months after the fact. Meanwhile, your payroll is due in two weeks and your cash flow is $5,000 short of meeting payroll.
So, you sell the $10,000 invoice to an invoice factoring company and get 90% of the total value of the invoice right away, which is equivalent to $9,000. Now you can make payroll and you don’t have to worry about tracking down payment for that invoice.
When the customer does pay the invoice to the factoring company, they’ll pay you an additional $500 while keeping $500, which is 5% of the total invoice value, as their fee for managing the invoice.
Things to Consider with Invoice Factoring
When you sell your invoice to an invoice factoring company, you’re also selling your customer accounting interactions, which could be quite valuable. Before selling an invoice, make sure you consider these crucial factors because they can have a very large and devastating impact on your business if you’re not aware of them from the start.
Take some time to learn about the company repayment terms. In the event that your customer is not the one who pays your invoice, you might be liable to return the cash advance that the factoring company paid you.
This is known as recourse. On the other hand, non-recourse terms mean that you do not have to pay back the advanced funds if the customer fails to pay. The company assumes all of the risks in that case. But keep in mind that non-recourse agreements tend to have higher fees since they are assuming more risk.
Make sure that the company you choose for invoice factoring knows and understands your industry. This will help them understand your business and the challenges you face within your industry. The needs of the transportation industry vary greatly from other common industries that use invoice factoring, like staffing firms.
Customer service might be the most important aspect that you’ll want to consider when looking for an invoice factoring company. Since you’re selling the right to collect on payment from your customers, you’ll want to know that the invoice factoring company will be kind and respectful while providing the utmost level of customer service to your clients. You’ll also want to know that the company will be available to you when you have questions as well.
The total price you pay for invoice factoring will have a direct impact on your bottom line. Even if you need the advance on the invoice to fund your business, make sure that the total price of invoice factoring is fair and competitive. Also, ensure that it will have minimal if any, poor effects on your bottom line.
Invoice factoring is a complicated service. It requires careful planning, consideration, research, and a solid understanding of your risks. But it’s also important that a company knows how to follow up on outstanding invoices and ensure timely payment from the customer. All of these skills take time to develop, so you don’t want to work with a new invoice factoring company that has little to no experience with the process. Look for a well-established company that has extensive experience.
Find an invoice factoring company that is flexible and easy to work with, too. The more rigid the company is, the less likely you’ll be to sell another invoice to them. Ideally, you will want to start off with a relationship that you see as valuable so that you have the option to turn to the company when you need their help the most.
Advantages of Invoice Factoring
Invoice factoring has many great benefits. Here’s a look at some of the advantages that you might experience.
- Fast Cash – You’ll get cash for your invoices within a couple of days. This can help immensely in terms of meeting financial commitments. It can also help you get the money necessary to complete truck maintenance and continue selling your services.
- Improved Business Operations – A lack of cash flow can have serious impacts on a business. Invoice factoring can help you improve your operations while avoiding total business closure.
- Less Expensive Compared to a Business Loan – Taking out a loan can cost your business a great deal. Invoice factoring works with the money you have earned and takes a much smaller fee compared to a loan.
- Reduction in Accounting Overhead – Managing accounts receivable requires the use of many staff members, which causes their to be alot of overhead. Paying anywhere from 1% to 5% for invoice management can be much more affordable than managing your own invoices.
Disadvantages of Invoice Factoring
While invoice factoring has many great benefits, it isn’t for everyone. Here are some of the disadvantages you might experience.
Detrimental to Your Customer Relationships
The invoice factoring company will work directly with your customers to collect the payment that your customers owe. Depending on how they treat your customers and the overall experience your customers have with them, you might lose customers over something that wasn’t your company’s fault.
Cost of Your Invoice Factoring Depends On Your Customers’ Credit
You have no control over your customers’ credit, but that number will influence how much you have to pay for invoice factoring. This impacts how risky the invoice is for the factoring company to take on.
Liability for the Final Payment
Depending on the terms, you might have to repay the invoice factoring company if the customer doesn’t pay their invoice. The invoice factoring company might assume all of the risks for the invoice or they might require shared risk. If your repayment terms are recourse or the latter, then you might be liable for the full invoice amount if the customer fails to pay. This could further harm your cash flow and cause problems later.
Requires Large Commitments
Handling just one invoice here and there won’t be very beneficial to the invoice factoring company overall. As a result, they’ll likely look to take on the majority of your accounts receivable or enter into long-term contracts. These relationships can be challenging to sever once you’ve started them as well.
Invoice Factoring vs Invoice Financing
The main difference between invoice factoring and financing is who collects on the payment. With invoice financing, you still retain the right to the invoice and the right to collect the payment. In contrast, with invoice factoring, the company will be responsible for collecting on the invoice.
Both options provide an advance of the invoice to the company directly. These are just two different ways of ultimately collecting the funds.
Funding a Transportation Company
Transportation companies face unique funding challenges. You have many funding options, ranging from invoice factoring to traditional funding and various options in between.
If you’re looking for a reliable and experienced partner in your transportation company’s finances, look into TAFS. You’ll get access to funding to aid in cash flow challenges with affordable flat rates. As an expert in the industry, TAFS makes it simple to access these great resources.