It’s no secret that small business owners find it hard to qualify for small business loans from banks. These traditional lenders base their loan application approval on your company’s proof of viability, credit rating, capital, yearly profits, and other financial credibility factors.
A good credit score, at least two years in business, and a stable cash flow increase your chances of qualifying for a loan. If you’re unable to meet these requirements it may be difficult to secure critical financial assistance from lenders. Luckily, with invoice factoring, your financing options will no longer be limited.
What Is Invoice Factoring?
Invoice factoring is a type of financing solution that allows business owners to sell pending invoices at a discount. The factoring company will give you an amount equal to 80%-90%of the invoices upfront. You can receive the remaining sum when the factoring company collects the dues from the customers. However, a factoring fee will be held as payment for their service.
To illustrate this concept, let’s say you have invoices that are worth $1M. The factoring company gives you 900,000 upfront. When your customers pay them, the factoring company will give you the rest of the unpaid balances minus their fee. Here are a few terms that you need to learn to understand better how invoice factoring works:
Cash that customers are bound to pay after you deliver goods or services according to the contract or terms of transaction you and your customers entered into. After the sale or service is done, you send the accounts receivable or invoice to them containing the amount owed.
The duration of the invoice term is normally from 30 to 90 days. Your customers should pay you when the invoice term expires. However, you don’t have to wait until the end of this term to get your money with invoice factoring. You can get immediate cash once you make the sale and sell the invoices to your factoring company through invoice factoring.
Similar to banks, a factoring company is a third-party lending institution. The difference is that they won’t grant you a loan, but they will purchase your invoices at a discount. Factoring companies prioritize your customers’ financial capabilities and payment history, but they will also conduct their due diligence and check your business and personal credit score. This process ensures that your customers can pay for the invoices or are creditworthy.
When Might You Need Invoice Factoring?
With today’s unstable and unpredictable global economy, business sectors have become more vulnerable. Now more than ever, small business owners need to have solid working capital to survive in difficult situations. It’s not enough to just have the funds pay off daily expenses, which some companies don’t even have. Companies need to have positive cash flows and be in control of their finances.
Invoice factoring is a great option for businesses that face cash flow issues due to pending invoices. Let’s say your company sells 60-day invoices. Most of your customers will pay within 60 days, some pay on the 60th day, while others go over the limit. This gap in cash flow can put a dent on your business’ finances.
With invoice factoring, you don’t have to wait for 30, 60, to 90 days to receive the money your clients owe you. You’ll receive the funds almost immediately and you can use it for almost any business purpose, including payroll, additional working capital, and day-to-day expenses.
5 Ways Invoice Factoring Can Help Your Small Business
1. It Makes the Accounts Receivable Process Easier
Instead of spending all of your time and effort collecting payments and follow-up on customers, you can focus on your business. Your company’s accounts receivable process won’t be such a hassle if you have someone else to do it for you. The factoring company will handle the cumbersome responsibility of payment collection.
2. The Collection Process Will Be Handled Professionally
Your company’s payment collection will be handled by professionals. These organizations specialize in formal follow-ups and payment collection using effective methods. However, it’s also important to get a reputable factoring company. The last thing you want is to damage customer relations because of poor collection practices.
3. It Improves Your Company’s Reputation
With invoice factoring giving your small business a steady flow of income, investors are more likely to invest in your business seeing that your company is stable. Suppliers and clients would be encouraged to work with your company too, given that your cash flow is reliable.
4. Acquire Working Capital without Incurring Debt
Applying for a loan is one of the first things people think of doing when they are short on cash. But if your business is already having difficulty paying monetary obligations, taking on more debt can be more damaging. For people who own a small business, factoring invoices allows them to get quick cash without incurring debt. They’re directly receiving money that is already owed to you. They don’t have to worry about getting collateral first or paying for interest later.
5. Better Chances of Approval
Small business owners have a stronger chance of getting approved for invoice factoring than for a loan with other lenders. Even without good credit, you can still get approved because the factoring company will focus on the customers’ credit score to assess the risk. Because you don’t need to acquire a mortgage or other collateral when you apply for invoice factoring, the process is faster and easier.
Is Invoice Factoring Right for Your Business?
Invoice factoring is a great financing option for businesses looking for fast cash. It requires less paperwork compared to traditional funding, and borrowers with a low credit score will likely qualify. If you choose to go with invoice factoring, be sure to evaluate your business’ needs before you apply.
Ezra Neiel Cabrera and Luisa Nacpil of SMB Compass