An invoice factoring service helps your business secure alternative financing by selling its outstanding invoices to a third party. This third-party business then has the authorization to collect payments. The firm returns a portion of the invoices to the issuing company, minus a fee for the third party.
How It Works
A factoring service works differently from traditional loans in that approvals are generally faster, and businesses do not need perfect credit. The values of the invoices serve as collateral, since the invoices are legal obligations between two parties. The financing is repaid when the factoring firm collects the invoice, which can happen within days or weeks rather than months or years. Therefore, factoring is a short-term financing solution for companies that need extra cash flow.
Your chosen factoring service may examine your accounting to see if your books look good. The business might peek into a year's worth of financial history to see if customers generally pay their invoices on time or if there are problems with late invoices. This step is important because factors are not, legally speaking, collection agencies.
The factoring service wires your firm an advance on the invoices, which is usually between 70 and 90 percent of the overall value. After a customer pays an invoice, you receive the rest of the money from that transaction minus a service fee. The fee is usually 2 to 6 percent of an invoice, depending on the volume, total value of the invoices, risk and billing structure.
Things to Remember
Your company might pay larger sums to a factoring service if your remittance terms let customers pay invoices after several months rather than weeks. If your customers take a long time to pay, you probably need a long-term loan from a bank or traditional lender to meet your financial needs. Even though the repayment rate of 2 to 6 percent might seem low compared to interest rates, a factoring business completes its work in a few weeks or a month. The factor could also incur fees that would eat up the advance you receive.
The advance your company receives can occur during a time-sensitive moment for your company. Perhaps your firm receives a big order and you don't have the capital to order more raw materials or pay staff to fulfill the orders. The advance your company receives in two days can see your company through a month or two of high demand. Remember, you get to keep, on average, of 94 percent of the value of the invoices minus any fees. If you have a time of prosperity that lets you earn and expand your business, factors can help you get by until your new customers come through and pay their invoices.
There are many details you must consider before signing with a factoring service. Go with a company that's transparent and upfront about costs, fees and procedures. Make sure you trust the company you hire and run the numbers so you still come out ahead after customers pay their invoices.
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