The process of invoice factoring is simple; in basic terms it is the act of selling your business’s accounts receivable (i.e. invoices) to a factoring company. That factoring company then pays your business a percentage of the value of the invoices. However, although in those terms it sounds like a ‘no brainer’, in actual fact there is a lot to consider. Below is a more in depth description of the advantages and disadvantages of invoice factoring.
The process for selling your invoices to a factor or factoring company is a little more complex than just exchanging invoices for money. All factoring companies will require you to sign a contract lasting a minimum of one year and during that time you will be expected to meet certain agreed upon terms and conditions of the contract including minimum accounts receivable values and service charges.
Most factoring companies will require you to provide a minimum value of accounts receivable for them over the course of the contract. On top of this, you will be expected to pay fees for the service provided. The fees usually range between 1.5% and 3% of the total value of the accounts receivable, depending on the contract duration and the value of the invoices. You can attempt to reduce the fees associated to your account by increasing the contract duration, though this does come with some risks.
It is important to find a factoring company that specializes in dealing with the level of accounts receivable you are able to provide. What this means is that there are companies that deal with massive levels of accounts receivable totaling in the millions of dollars, and also factors that specialize in invoice values in the tens of thousands of dollars, and while most companies can accommodate your needs, the costs in doing so may not be relative to your level of invoice value.
Many businesses go through the year with varying levels of cash flow month by month. Although this is due to many reasons, one of the big ones is clients failing to pay their invoices on time. For a business, reduced cash flow because of this could mean that they are unable to pay their invoices. This is why many businesses choose to use factoring companies, so that they are able to effectively obtain invoice payments immediately, boosting their cash flow. The problem is that by factoring your invoices, you will be receiving less than the value of the invoice, and therefore loosing money. Ultimately, the question is whether it is better to use the owed money for your own business’s growth, or to effectively be your customer’s bank.
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Tags: Business, Finance, invoice factoring, small business
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