Invoice factoring is a very popular financing method that is used by many businesses, big and small and is rapidly rising in popularity. The principle behind invoice factoring is simple, it allows businesses to sell their outstanding invoices in return for immediate cash. In most cases, the factoring company will pay you 80% of the total beforehand and pay you the rest after the invoices are collected, minus fees.
The method has many advantages over other financing methods but is not made for everyone. In this article, we’re going to address whether invoice factoring is the right choice for your particular business.
Can Your Cash Flow Needs be Met with Invoice Factoring?
Please note that most people who use invoice factoring do not do it to make major purchases or investments per se. They usually do it because they have cash flow issues and usually have to cover operation costs. Invoice factoring is more suited for these types of needs.
Accounts receivable financing companies cater to one specific type of client, and that is one that cannot wait 30 to 90 days for their invoices to be collected. So, if you were looking to make a major investment, like buying new equipment or making renovations, invoice factoring might not be the best option for you. However, if you have immediate needs like payroll, suppliers to pay, or rent and utility bills, invoice factoring might be for you.
Do Your Margins Allow You to Cover Factoring Fees?
As you may already be aware, invoice factoring is not free and there are fees associated with each factoring cycle. And because of its nature, many people wrongly believe that it is a cheap financing option. While it may be easier for some to use invoice factoring because of how convenient it is, it is certainly not the cheapest financing option available. Many factors may affect invoice factoring costs, such as sales volume, customer credit quality, and invoice diversification, for instance. As a general rule of thumb, only companies with margins exceeding 15% should consider invoice factoring. However, this rule is not absolute and in some cases, you may have no other choice but to incur a momentary loss depending on your situation.
Do Your Clients Have Good Credit?
One of the things people often overlook with invoice factoring is that your clients’ credit will be as important as your own. With credit factoring, you send invoices from good customers to a third party company who pays upfront. For this reason, the company whose invoice will be factored should have a good credit score. Factoring companies will usually assess the company’s commercial credit through a D&B commercial credit report and the company will have to qualify for credit exceeding the amount that will be lent.
Can Your Company Qualify for Factoring in the First Place?
Most important of all, you should ensure that your company can qualify for invoice factoring in the first place. One of the most important factors when assessing whether you’ll be able to qualify for factoring is to make sure that all your invoices are free of any security interests or liens. There are many instances where there can be liens on your invoices. For instance, if you have already secured financing through a bank loan, there is the possibility that your bank placed a lien on your invoice as a collateral. Another case is if you have a tax lien. In this case, taxing authorities may have a lien on your invoices. Also, if you’re currently being sued or under judgment, then there are chances that your invoices might be encumbered by liens as well.
In addition to not having liens on your invoices, your company should have a history of delivering orders on time and in good condition and have solid invoicing practices.
As you can see, while invoice factoring might be a godsend for some businesses, it is not for everyone. Invoice factoring should only be reserved for those who cannot afford to wait for their accounts receivable to come in. Also, you should have enough margin to cover the expenses. In addition, your clients have to be in good standing as well and your accounts receivable have to be free of any liens. And last, but not least, your company should have a reputation for delivering on time and with minor issues as well as having clear and thorough invoicing practices.