Invoice factoring or accounts receivable financing is often leveraged by small businesses as a way to get the working capital necessary for expansion. However, if you haven’t heard of the concept before, you’re missing out on all the benefits a factoring company can offer. Below, we’ll break down the basics, so it’s easier to see if invoice factoring is the right tool to help your business grow.
Why Invoice Factoring Matters
Each working capital solution is appropriate for specific situations, and invoice factoring is no different in this respect.
Best for Small Businesses That Need Cash Fast
Most working capital sources take weeks or months to process and approve your application. With invoice factoring, you get fast cash. Small businesses can usually get cash within a couple of days or even on the same day if they’re working with a factoring company like Charter Capital.
Best for Startups Expanding Their New Businesses
Startups normally have a very difficult time qualifying for financing because they haven’t been in business long. Time in business is not a major factor in qualifying for invoice factoring, so it’s much easier to get approved.
Best for Business Owners with Low Credit Scores
When faced with denials on a business level, many small-business owners turn to their personal scores and creditworthiness to get business funding. However, roughly 39 percent of small-business owners qualify as “credit ghosts” according to the Miami Valley Small Business Development Center. That means their personal credit score is 620 or lower and they have a limited credit history or no history at all. It’s all but impossible to qualify for traditional financing with this background.
The problem is further compounded by the very steps business owners often take in light of their credit woes and capital shortcomings. A full 51 percent of successful entrepreneurs have willingly denied themselves a paycheck to keep their business afloat, per a Business News Daily report. More than a quarter held off on their own pay for two to six months, while an almost equal portion went six months without an income. Meanwhile, CNBC reports that 21 percent use their personal savings. These things essentially lock in their status as credit ghosts, creating a cycle that drains their personal reserves and diminishes their personal creditworthiness even more.
However, invoice factoring doesn’t rely on personal credit and allows business owners to tap into cash without using their personal savings or trapping them in debt. This makes it easier to qualify and gives the business owner a leg up in establishing good credit, a twofold solution to this common business problem.
Why Would a Business Use Factoring?
Businesses use factoring to address a multitude of situations.
Cash for Expansion
Sometimes companies use their invoices to get the cash they need to purchase another location, tap into a new market, or expand in other ways.
Payroll and Other Daily Operational Expenses
Because payroll is often the greatest expense for small businesses, organizations often use their invoice advances to cover it and ensure their teams and employees are paid on time, even if customers aren’t paying in a timely manner. For example, staffing factoring is frequently used by staffing agencies to maintain steady payroll funding without waiting for client payments.
PPE
Businesses today are coping with a major unexpected expense—personal protective equipment (PPE). Although most don’t have a budget for purchasing things like masks, or even extra disinfectant, they’ve fast become a mandatory business expense.
Inventory and Supplies
Virtually all businesses must purchase goods from suppliers, including raw materials which are turned into an end product ready for sale or supplies, like fuel and printer paper. You can tap into your unpaid invoices to get cash for any of these vital purchases.
Equipment
From manufacturing equipment to trucks and tires or even office computers, invoice advances can supply the funds and provide a good financing option.
Paying Off Debts
Most business funding options rely on debt—you borrow money and then pay it back with fees and interest. When you’re working with a factoring company, there’s no debt to pay back, so it can be a good way to pay off high-interest loans or other debts with excessive fees.
Marketing
We talk about the importance of marketing in Top 7 Reasons Why Startups Fail. Suffice it to say, it’s important to keep up with your marketing efforts if you want your company to grow. Many organizations use the cash tied up in their invoices to enhance their marketing efforts, so they can build a healthier business.
Securing Better Deals or More Work
Oftentimes, vendors will offer better deals to companies that place larger orders or pay in advance, but you’ll need to have working capital at the ready to lock in a deal. Leverage invoice factoring for a quick cash flow injection.
Offering Better Payment Terms to Win More Business
When you know that you’re going to get paid promptly regardless of how long the customer takes, you’re free to provide better terms, such as a more competitive bid or a longer repayment term. Factoring will allow you to do this, so you can improve customer satisfaction and win more business.
How Invoice Factoring is Being Used to Improve Cash Flow
What are the benefits of invoice factoring? Invoice factoring works by providing you with an instant cash payout for your outstanding invoices. It shortens the length of time between performing work or delivering goods and getting paid for your efforts. That way, your cash flow is consistent, and your business operations aren’t held back by slow-paying customers.
Small Business Can Use Invoice Factoring as an Alternative Financing Option to Loans
Small business factoring is an ideal alternative to business lending in many situations, particularly when cash advances are required quickly. As demonstrated earlier, it works when businesses or business owners don’t qualify for traditional small business loans. However, it’s also beneficial when the organization simply doesn’t want to take on more debt. That might be true if you’re trying to build your credit in advance of a loan application or are trying to minimize your debt ratio for other reasons.
One of the primary benefits of invoice factoring is its flexibility across various industries. For example, security factoring helps security guard firms maintain stable cash flow to cover payroll and operational costs, allowing them to focus on providing top-notch security services without the financial strain of waiting for customer payments. This industry-specific approach demonstrates how factoring can be adapted to meet the unique needs of growing businesses.
What Are the Disadvantages of Invoice Factoring?
With so many benefits to invoice advances, it might be hard to see the downside. However, it’s worth noting that it’s not right for every situation.
You Must Submit Each Invoice to the Factoring Company to Obtain Funding
When you work with a factoring company, it’s usually up to you to decide which unpaid customer invoices to factor and when to factor them. That’s usually a good thing because it means you can process all your other invoices as you normally would and only leverage factoring when you have immediate cash needs or when you know a client will pay slowly. However, the flip side of this is that, to obtain funding, you do need to send your factoring company each invoice you want to factor.
Your Factoring Company Will Have Contact with Your Customers
The factoring company has the right to communicate with your customers to collect the invoices and to make sure all is OK. Most organizations are familiar with third parties in billing, so it’s generally not an issue, but it is worth mentioning. Make sure that when you select a factoring company, you choose one that is known for its customer service and its ability to work with you and your customers.
How Much Does Factoring Invoices Cost?
We dig into the cost of factoring a bit more on our website, but the short version is that it depends on things like the volume of invoices being factored, the total value of factored invoices on a monthly basis, and how long it takes your customers to pay. Charter Capital prides itself on offering some of the most competitive rates in the industry, with some factoring fees as low as one percent.
Get a Complimentary Rate Quote
If you think invoice factoring might be right for your small business, start with a complimentary rate quote from Charter Capital.
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