Businesses are often haunted by customers who consistently pay their invoices later than expected, or by those who don’t pay at all. A great deal of time, effort, and resources can be consumed by chasing after delinquent accounts receivables, while the effect on cash flow can become a big problem in itself.
Enter the world of invoice financing, “a form of asset-based financing and a way for businesses to borrow money against the outstanding invoices from customers,” according to Nav, a business lending advisory firm.
How does invoice financing work? The simplest form is known as invoice factoring. Generally speaking, a business sells its outstanding invoices to a factoring company, which in turn pays the business a set sum, usually between 70% and 90% of the invoices’ total value. The factoring company assumes the role of payment collector, charging a fee for the services they provide (frequently, a percentage of the amount of the invoices).
Unlike conditions surrounding a traditional business loan, with invoice factoring, a cash-strapped business has almost immediate access to cash. A company’s credit score or loan history isn’t usually involved. Plus, there are no long waiting periods for approval, once a factoring company decides to purchase the outstanding invoices.
Invoice factoring can become a staple of a business’s ongoing cash-flow strategy. Since the emphasis on the value of the invoices, the invoice financing line “can easily increase as your invoices increase in value, given that your clients remain creditworthy,” notes SMB Compass, a business financing company. Such a financing option “is great for rapidly growing companies needing financing to keep up with the rate of growth.” In general, business owners aren’t fond of tracking the status of invoices and chasing after customers who are late or delinquent in payment. With invoice factoring, that burdensome task falls on the factoring company.
Invoice factoring isn’t cheap. Charges for the service may include credit check fees, as well as application and processing fees. Generally speaking, the charge is between one percent and five percent of the invoice’s total value—an important consideration for businesses needing quick access to capital.
Factoring companies closely examine customers’ payment records when determining whether or not to assume control of a business’s invoices. “If your customers have a habit of not paying on time,” notes the financing company Fora, “the factoring company will assume they won’t be paid on time either and will be less likely to take on your invoices.”
When it comes to debts, some businesses don’t care to relinquish total control to a third-party service provider. They worry about an invoice factoring company contacting their customers directly, in pursuit of payment.
Invoice financing is a bit different from what’s been described above. As Fundera explains, the lender “gives you a portion of your unpaid invoices—usually 80% to 90%–upfront, in the form of a loan or line of credit.” When the customer pays the invoice, “you’ll pay the lender back the amount loaned plus fees and interests.” Your business retains responsibility for the collection of outstanding customer payments.
The pros and cons are similar to invoice factoring. On the plus side, getting cash upfront lessens the pressures a business may experience when faced with outstanding accounts receivables. Having a low credit score doesn’t necessarily disqualify a business for this type of financial assistance; rather, invoice financing companies focus more on the credit scores of that business’s customer base.
Again, invoice financing may be too costly for some businesses to handle. And companies that don’t like third parties contacting their customers may feel that the potential negative impact isn’t worth access to capital.
Want to learn more about coping with the challenges of consistent cash flow? Register for our free TAB Boss Webinar, “Working Capital Financing Strategies: How to Increase Your Cash Flow.”