Are you wondering whether or not your business should use a factoring company? Here are all of the tools you need to help you make your decision.
Have you found that you’re in a financial bind? In this case, you might be able to get help from a factoring company.
It isn’t rare for businesses that invoice clients to find that they’re in a situation in which they’re in a financial bind while waiting for clients to pay them. Typically, this amount of time is 10 to 30 days, though sometimes it might be even longer. For companies with more capital access, this might not be a problem, but for businesses that are just starting out or for smaller businesses, waiting for their clients to pay their invoices can cause their business-as-usual to grind to a halt.
For companies that end up finding themselves in this type of situation, a solution can be a factoring company. Invoice factoring can assist a business in getting a quick cash boost, and with fewer restrictions and less paperwork than what a bank may require.
What Is Factoring?
Factoring is a process of releasing the cash that has been caught up in invoices that are unpaid. If you’re asking, “What is a factoring company?” we’ll answer that question now. A factoring company gives you a cash equivalent on a percentage of the total of your unpaid invoices. Then they’ll work to collect those unpaid invoices. When the invoice is finally paid, the factory company will give you the cash—subtracting a percentage amount for the services they’ve provided.
In some cases, factoring is a better option than a bank loan. For one thing, working with a factoring company involved less paperwork than how much would be involved when working with a bank. The cash that companies get, they’ll get more quickly. And because they’re collecting against your business’s invoices, factoring companies will be less interested in your credit score than your clients’ creditworthiness. Even if you don’t have perfect credit, a factoring company might still help you.
Of course, factoring has downsides. When a small business or other-sized business works with a factoring company, the business is using factoring as a type of loan. So if you hire a factoring company and your customers don’t end up paying the factored invoices within an amount of time that’s agreed upon, you’d need to pay the debt that was outstanding back.
Another issue is that factoring can sometimes be expensive. Compared to conventional loan charges, factoring can cost several more percentage points. It’s also common that factoring companies charge per invoice. So if you have many unpaid, small invoices, a factoring company’s services might be too expensive for you.
However, there are times when working with a factoring company makes a lot of sense, and it’s worth the impact and financial risk.
Industries That Commonly Use Factoring
In this list, you’ll find some of the business types that use factoring so they can get the funding needed to continue running their businesses:
- Freight brokers
- Transportation and trucking
- Staffing agencies
- Construction companies
- Cleaning and janitorial companies
- Commercial food services
Why Use Factoring Services?
In the modern world of business, things move fast, so opportunities can sometimes appear and disappear quickly. For instance, picture a situation in which you had the opportunity of landing a big new client, but this would only be possible if you were able to provide inventory very fast. In this imagined scenario, your manufacturing processes would be up to the challenge, but you wouldn’t have all the materials needed. If you had the right amount of cash, you would be able to ramp up production and deliver what the new client wanted. By using factoring, you would be able to have the cash necessary to seize the opportunity, with the knowledge that you’d make money you lost on the fees with what the new client paid you.
When you’re thinking about business tools and options that can help you improve, in the short term, your cash flow, there are certain situations when factoring is a logical option. Now, we’ll review some of the good reasons why you should consider hiring a factoring company and using their services:
1. Ensure Employees Get Paid
Sometimes, a company will use factoring just because it makes it possible for them to keep their business moving forward. If you’re waiting on an invoice and this is putting you at risk of not being able to pay your employees, it might be worth including factoring in your business plan.
This way, you’ll be sure that you’ll be able to pay your employees, using the money the factoring company provides you with as a stopgap measure.
2. Improve Cash Flow From Slow-Paying Customers
If you have a well-known, large client who is slow when it comes to paying, factoring can be quite effective. Because a client like this is a good credit risk, factoring companies are likely to take this invoice on. The money you receive from the factoring company can help you when it comes to bridging the time between when you provide the factoring company with the invoice and when the client pays the invoice.
3. Maintain Positive Relationships With Clients
Factoring also makes it easier to maintain good relationships with your clients that you want to continue doing business with. If you send an invoice to a debt collector, you could end up souring the relationship. However, sending your client a professional notice that explains that their invoice is in the process of being factored can ensure you’re putting cash in the bank account that belongs to your business while keeping the relationship solid.
4. Meet Short-Term Cash Needs
For companies that have short-term cash needs, factoring can be a bonanza. It’s a relatively easy and quick way of injecting cash into the business for growth and short-term expenses. However, as one should with any type of business loan, a business leader should use caution when approaching factoring. Carefully think about the use and terms only when, within your business strategy, factoring is a business risk that’s acceptable.
5. Avoid a Loan or Line of Credit
In the majority of situations, getting a line of credit or loan from a credit union or bank is the cheapest way of quickly financing a business. However, not all business owners—or businesses—can qualify for a loan because they don’t meet the minimal requirements. If you don’t qualify for a traditional type of loan, whether that’s because you have outstanding debt, a low credit score, or for another reason, you can quickly receive funds by working with a factoring company.
Costs of Using Factoring Services
When you start searching for a factoring company to work with, you need to identify two specific rates. One is the advance rate and the other is the factoring rate.
The advance rate is how much of the invoice you’ll receive, as a percentage, when you submit the invoice to the factoring company. Depending on your industry, the advance rate varies. Generally speaking, it’s somewhere between 70% and 95%. As for the factoring rate, this is what the factoring company will charge you for the services they provide you with. Depending on the industry, the factoring rate can vary too. Usually, it’s somewhere between 1% and 5%.
In the majority of cases, a factoring company will use one of two pricing structure types. One of these is fixed-rate and the other is time-based. Here’s how they are different from each other.
This is a straightforward and simple pricing structure. When they use this structure, the factoring company will provide your company with a flat rate for the services they’re providing you with, whether or not your client ends up paying their invoice. This type of fee is not always available with factoring companies, but if your clients pay consistently and are reliable, you can come to this agreement type with a factoring company.
Example of a Fixed-Rate Fee
Let’s say a factoring company has an advance rate of 85% and a fixed rate fee of 2%. If you submitted a $1,000 invoice for them to factor, you would get, in one to three business days, $850. When your client finally pays the invoice, you’ll receive the remainder of the invoice, subtracting the factoring fee of 2%, so this would total $20.
The variable rate, or time-based, the structure is the factoring industry’s most common pricing standards type. It’s a bit more complicated, too. When you use this contract type, the factoring rate is determined by how long your client takes to pay their invoice. So the fee will be lower if your client pays quickly. But if it takes them a significant amount of time to do this, months, for example, the costs quickly add up. Based on what industry you’re in, time-based rates vary, but usually, they’ll follow one of the formats below:
- 3% for every 30 days, plus 1.25% for every 15 days
- 2% for every 20 days, plus 0.25% for every day after
- 1% for every 10 days
Example of a Time-Based Fee
Assume that a factoring company has an advance rate of 90% and charges 10% for every 10 days. Say that you submit three invoices from three different clients, each of which is $1,000. In this case, you’d receive $900 for each invoice within one to three business days. The first client pays quickly, in only five days, so you get back the entirety of the invoice except for $10, which is the factoring company’s fee. The second client takes a little longer to pay, 11 days, so the fee is $20 for this invoice. The third client takes even longer, 40 days after the submission of the invoice, so you’ll be charged $40.
Find out if factoring services are right for your company today.