Invoice Factoring for Small Business


Mark Oswego

Sep 14, 2021


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Accounting & Finance

As a small business owner, it can be challenging to juggle your cash flow. What do you do when a large client has 30 or even 90 days to pay you, but you have bills to pay now? Large corporations find it easy to secure lines of credit, but smaller businesses often struggle to secure working capital. If you approach your bank about a loan, you may find the adage painfully true — you can only borrow money by proving you don't need it. Fortunately, invoice factoring is often a viable solution for small businesses, sometimes providing the cash you need in as little as 24 hours.

Factoring for Small Business - The Basics‍

Invoice and a stack of cash

Invoice factoring is a way that small business owners can acquire cash quickly without going into debt. Factoring allows you to sell your unpaid invoices to a factoring company for money. Rather than waiting for your client to pay you in the typical 30, 60, or even 90 days, you sell their outstanding invoice for cash now. This sale allows you to collect payment quickly while still offering your customers reasonable (and often standard or expected) payment terms.

Recourse Versus Non-Recourse Factors‍

When engaging in a factoring transaction, there are two types of factors to be aware of. The simplest is the non-recourse factor. You sell an unpaid invoice to the factoring company in this arrangement, and the transaction is complete. Once you pay the factoring fees, you don’t have an obligation to the factor. If your client defaults and doesn't pay the invoice, it's up to the factoring company to collect. You need not chase down the money yourself, wasting valuable time, effort, and resources on debt collection.

Recourse factors work a little differently. Under a recourse agreement, you sell your invoices to a factoring company but are ultimately still responsible for collecting the amount owed. If your client defaults on the invoice under this agreement, you will have to repurchase the invoice from the factoring company or replace it with an invoice of equal or greater value.

Factoring Payments and Fees‍

Of course, nothing in life is free. In exchange for fast cash, you pay the factoring company-specific fees. Typically, the factoring fee is between 2 and 6 percent of the invoice total. Some companies charge a flat fee. Others may charge a factoring fee based on the amount of time it takes to collect payment. A factoring company may, for example, charge a fee of 1 percent per outstanding week. If your client repays the invoice within three weeks, the factoring fee would be 3 percent.

A typical transaction works like this: You find a company that offers factoring for a small business. You sell them an unpaid invoice. They pay you 80 percent of the invoice's value today. The factoring company pays you the remaining 20 percent minus their fees when your client pays the invoice.

Small Business Factoring Qualifications‍

Person checking his credit score on the laptop

It's important to understand that although factoring is often an option when other business financing options are not, it's not guaranteed. Some factoring companies require the small business owner to have a particular credit score. This score is usually 530 at a minimum. Other organizations are far more concerned with the creditworthiness of your clients. They may request account repayment histories on your clients to make sure they pay invoices on time.

Factoring companies often prefer to work with B2B companies, as well. The theory here is that businesses are less likely to default on an invoice than an individual, meaning B2B companies are more likely to issue viable, collectible invoices. Some companies set a minimum invoice limit, as well, often of around $500.

Note, too, that factoring companies often wish to work with small businesses that are willing and able to sell large batches of invoices or invoices periodically. Some companies offer spot factoring, allowing you to sell one invoice at a time on an as-needed basis. These arrangements can prove challenging to find, however, and tend to come with higher fees.

‍Pros of Factoring for Small Business‍

Man with cash in hands

The most significant benefit of invoice factoring is that it allows you to get cash now without going into debt to do it. Factoring lets you sell an asset (unpaid invoices) rather than borrowing and creating debt. Instead, you can keep your cash flowing quickly without asking your customers to pay you more quickly.

Invoice factoring is also a much easier way to get cash than borrowing. Generally, factoring companies focus on the number of your outstanding invoices and the creditworthiness of your customers. These data points mean you can get the money you need even if you lack collateral or have less than perfect personal credit.

An added but hidden bonus of factoring is that it allows you to spend less time working in the business versus on the business. When you're working in your business, you're performing essential tasks but not doing the things that let you grow and expand. Working on the business involves networking, planning, goal-setting, and developing systems that allow you to extend your reach. Collecting invoices is an integral part of working in your business, but it's a task that you should delegate to focus on setting and meeting company growth goals. Non Recourse invoice factoring is an excellent way to delegate invoice collections and cash inflow activities to free up your time.

Cons of Factoring for Small Business‍

Invoice closeup

Invoice factoring isn't a perfect solution. For starters, it's admittedly an expensive proposition. You must be willing to lose a percentage of every invoice you sell to utilize this option. If, for example, a factoring company charges you a flat 3 percent fee, you'll surrender $300 of every $10,000 you factor. Not every small business is willing or able to do this.

Remember too that factoring depends on customers with solid payment histories. If your customers start defaulting on their invoices, their poor payment history could prevent you from continuing to sell their invoices — even if you pay all your bills on time. If you sell directly to customers rather than to other businesses or tend to invoice small amounts, you may struggle to find a factoring company willing to work with you.

Factoring can also mean giving up control. If the company you sell the invoice to takes on the responsibility of collecting the invoice amount, you'll want to ensure that their collection practices are fair and acceptable to you. You don't want a factoring company that uses overly aggressive collection techniques to alienate your customers.

As beneficial a factoring can be when cash flow problems arise, you need to think of it as a temporary solution. It's great for covering a temporary shortfall, but your business may not survive if you can't pay your bills without factoring. Ultimately, you'll want to create a cash cushion that gives you a little breathing room if a large client pays late or has an issue.

At E-Marketing Associates, we want to help you grow your business and your cash cushion. We offer many tools for marketing online that can help you do just that in today's increasingly digital marketplace. We'll help you establish a marketing goal for your business and assist you in making a plan for reaching that goal.

After instituting the plan, we'll sit down with you and take an honest look at the plan's results. We'll celebrate what worked and tweak what didn't so that we can fix any problems and successfully move forward. Online marketing can be tricky, but you can do it, and we can help. Reach out today and let us help you grow your business and expand your reach.

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