Many businesses face cash flows problems, particularly smaller and younger companies. This can have a detrimental effect, leading to issues with fulfilling orders, wages and stunting the overall growth of the company.
Whilst it may seem like a lack of cash flow is a sign that a business isn’t doing well, often the complete opposite can be the case. A company may be taking on multiple orders, but their invoices aren’t being paid fast enough to keep up with demand. Free flowing capital is what pushes a business forward and when it’s not available it can affect current orders but also potential future orders as well.
One of the solutions to this problem is to borrow money from a bank, taking on a short-term loan and paying it back when your invoices are paid. This does work for many businesses but unfortunately, this isn’t an option available for everyone. In recent years, it has become increasingly more difficult to receive credit from banks, particularly for newer companies who may not have the credit history to qualify for a loan. Another issue is timing, as the need for cash flow is often immediate but the process of getting a loan from a bank can take a while.
An alternative to bank loans is the financial product of invoice factoring.
What is Invoice Factoring?
Invoice factoring involves the selling of unpaid invoices to a third-party or factor. The factor will take responsibility of the invoice from the company and pay them a percentage of this invoice upfront. Once the invoice is paid by the client, the remaining percentage will be delivered to the business, minus the cost of this service.
There are two types of invoice factoring- recourse factoring in which the business retains overall responsibility for the invoice; and non-recourse factoring, in which the factor takes responsibility. Most businesses opt for non-recourse factoring as it’s a much safer option.
Pros
The main upside of choosing invoice factoring is that it’s a quick and easy method for freeing up cash flow. In fact, some companies can receive their cash within 24 hours. This is particularly useful for small and medium sized businesses, as well as newer companies, all of whom may find it difficult, if not impossible to get a loan from a bank. Even those who can get a loan, may find that it takes too long to receive their cash and invoice factoring is therefore an attractive solution.
Another major benefit of invoice factoring refers specifically to non-recourse factoring, where the company relinquishes responsibility for collecting the debt. In this instance, you’re basically outsourcing this process and saving the time and effort it would take to collect this debt. This means you’ll have more time to spend on other aspects of the business.
Cons
Invoice factoring may seem ideal but there are a number of downsides which need to be considered before you make your decision. For example, this service isn’t suitable for all businesses. Invoice factoring can only be used by businesses who sell to other businesses, using credit.
Another aspect to consider is pricing. Of course, factors aren’t going to offer this service for free and they do take a percentage of the debt as payment. This is usually somewhere between 1% to 5% of turnover. Businesses need to ensure they can afford this cost, otherwise the benefits won’t be worth the damage to the business.
Factors will take control over collecting debt from customers, which is beneficial in that it saves you time but there is the potential for this to backfire. Debt collection doesn’t always run smoothly and you’re relying on a third party to treat your customers respectfully. Unfortunately, this doesn’t always happen and when a customer is treated poorly, it could lead to them shopping elsewhere.
For some businesses, invoice factoring is a life saver but it’s important to fully research this service before taking the plunge.
