Factoring Service Advantages And Disadvantages
A guide to the pros and cons of invoice factoring
In business, positive cash flow is vital to successful day-to-day operations and growth. If you've never used a factoring service you might be missing out on some big advantages to maintaining positive cash flow.
So what exactly is a factoring service?
Simply stated, it allows you to turn unpaid invoices or accounts receivables into immediate cash by selling them to a third party who then collects payment for you.
Sounds great right?
But before you start using a factoring service, let's look at some advantages and disadvantages of utilizing them.
As with any other type of funding, there are positives and negatives. We'll leave it up to you to decide which outweighs the other.
What Is the Factoring Service Process?
First, understand that you're not going to get 100% of the value of an invoice up-front when you turn it over to a factoring service.
In most circumstances, expect to be paid somewhere between 70-90% of the total value -- sometimes in as little as 24 hours.
Then, the factor collects the full invoice payment from your customer and forwards the remaining balance to you -- less a pre-determined service fee that varies for each service and circumstance.
They don't take on any invoice you present them, however. The factoring service will run your customers through a full credit check to ensure they will receive a timely payment.
In addition, the service will look at certain aspects of your business including your total overall revenue and how many years you've been in business.
After acceptance, the factor will review all of your outstanding invoices and check for completeness and accuracy. If everything aligns, the factor will request payment from your customers through a notice of assignment.
The notice of assignment explains to your customer that you are working with a factoring service and instructs on how payments need to be sent. After full payment is made to the factor, you'll receive the balance you're owed from the invoice.
So Why Doesn't Every Business Use an Invoice Factoring Service?
Factoring might sound like a win-win for everybody involved. In some ways it is. First, let's take a look at some important advantages of using one of these services.
- You get a good percentage of the money owed to you right away without chasing down clients.
- Factoring services are set up to receive payments very efficiently. Your customers will appreciate this.
- Factoring allows you the flexibility of knowing exactly when cash flow will be available. This helps with your overall planning schedule.
- As your business grows, so will your factoring line. You'll be able to factor more and more as invoice amounts increase.
- A factoring service doubles as your accounts receivable department. They collect your invoices, issue statements and keep detailed records of all payments. This is a great alternative to hiring more employees.
- Chasing down customer payments is a time-suck and a waste of resources. By factoring, you remove this headache from your company's workflow almost completely. Imagine how much work could be accomplished by lifting this burden from your employees!
- Increase working capital at any time by immediately getting up to 90% of invoice values in advance.
- Fast access to cash will allow you to pay suppliers quickly and make purchases for your business that may not have been possible without factoring. Ever fear you might not be able to make payroll? Factoring solves this problem quickly and removes that stress.
- Competition among factoring companies is high, which allows fees and pricing to stay competitive and fair.
- You'll gain useful credit information about your customers. In addition, they can help you negotiate improved terms with your current suppliers.
- If you choose non-recourse factoring, you'll be protected from bad debt.
There Must Be a Catch
With all that said, there are some disadvantages to using a factoring service that you'll want to consider. Like the old saying goes, "there's no such thing as a free lunch."
Here are some key disadvantages:
- Factoring companies sometimes utilize strict credit limits on your customers. This helps protect them from an individual customer owing too much and defaulting on payments. When credit limits are enforced it can impact your business.
- If for any reason you try to leave a factoring agreement before the end of the contract, it may not be allowed. Make sure you have a full understanding of this with the factor before entering an agreement.
- As you know, sometimes customers dispute invoice charges. When that happens it will be your job to settle the dispute quickly or face recourse.
- You no longer have accounts receivable power on your own invoices. You have to trust the factoring service to uphold their end and collect on all invoices. This can be a little scary for some business owners.
How Exactly Do Factoring Service Fees Work?
In general, pricing is based on the risk a factor is taking. Typical fees range from between 2-6% of each invoice.
This fee is referred to as a "discount rate". Your specific rate will also take into account factors such as:
- Invoice volume
- Risk in your specific industry
- Billing structure
- Your customer base (do you have mostly retail customers or business customers?)
- Client credit history
In addition, the fee you'll be required to pay will also be determined by your agreed upon payment terms. For some service providers, costs continue to rise the longer a customer takes to pay an invoice.
There are factors that allow you prepayment of invoices they covered. In these cases, you're only required to pay the discount rate on any outstanding invoice amount.
Can Invoice Factoring Work for a Trucking Company?
Freight bill factoring is a great way for trucking companies to free up cash and remove the headaches of chasing down invoices.
Here's how it works.
- Book your load then email or fax customer's details, load and rate to the factor.
- The factor replies to let you know if they are approved.
- You haul the load.
- Once the load is delivered, email or fax your BOL and other related documents to the factor.
- Within 24 hours the factor will pay you through direct deposit or your Comdata account -- typically between 60 - 90% of the billing total.
- The customer pays the invoice and you receive the balance, less the fees.
Factoring services play a huge role in the way current business gets done.
In this article, you've learned all the pros and cons of factors. Only you can decide if they are best for your business.