Invoice factoring is a good answer for businesses in need of short-term funding solutions. It lends a business vastly improved flexibility. Invoice factoring involves taking invoices due over a longer term and turning them into cash flow very quickly. If this flexibility is something a business needs in order to overcome funding shortfalls or to take advantage of unexpected opportunities, then invoice factoring is a good potential solution.
Not every invoice holds an equal value to you, though, so how do you decide which invoices to factor? These guiding steps can help:
1. Set a Target and Don’t Deviate
Know how much you need ahead of time. Don’t factor twice as many invoices as you need to in order to hit the cash supply target that you’ve identified.
Factoring means you’ll lose some value. This value is taken as a fee for the service provided. As business lending goes, the fees taken out for invoice factoring are remarkably reasonable and competitive. In many cases, they can offer a notable advantage over many types of lending…but this doesn’t mean you should cut corners in your own preparation.
2. Balance Short-Term and Long-Term Planning
Don’t be tempted to cash out more than you need. Any invoices factored will give you more cash supply today, but those invoices will also lose an edge off their value in terms of what you get for them. With this in mind, factor the invoices for the funding you need, but remember to balance your business’s long-term needs against the short-term. When money is involved, you always have to keep your goals clear.
The temptation of more money now might make you feel safe in factoring twice what you actually need. However, if you don’t have an immediate need for those extra funds, hold onto those additional invoices and keep that extra value edge. Margins are tight for many businesses. Factor close to the value you actually need. Make sure you’ve projected ahead for your business to ensure that factoring today still leaves you a good operating margin for the foreseeable future.
3. Factor Your Most Reliable Invoices First
Always keep in mind that your most reliable invoices should be factored first. This means you should factor those invoices most likely to be paid. When a customer fails to pay an invoice you’ve factored, the factoring company may take any number of measures. This can lead to additional fees and money owed by your company or a poor business relationship.
4. Read and Understand the Details
Should a customer fail to pay an invoice owed to a factoring company, the details of what the factoring company does in response will be explained in your initial contract. Make sure you understand the process. Even if your customer has been reliable in the past before, it can be difficult to predict what might happen in the future. Understand what happens if they miss an invoice payment so you’re prepared for all eventualities. Invoice factoring is tremendously safe, but fee assessments and responses to unpaid invoices vary by contract.
5. Not All Factors Act the Same
This is especially true for recourse factoring, where the factoring company can collect from your business if the customer fails to pay the invoice in question on time. This collection can involve additional fees, especially if your business takes additional time repaying the invoice.
For this reason, it’s often advantageous to opt for non-recourse or partial recourse factoring that possesses terms favourable to your business. If your invoices are less dependable than you’d like or your business is in a riskier industry, investigate non-recourse options for invoice factoring. This is fair to the invoice factoring company as well because they will assess the risk factor for your business. Fees, or the rates on which fees are based, may be adjusted accordingly in order to incorporate this additional risk, but you will be able to assure your company won’t be surprised down the line.
Partial recourse invoice factoring blends elements of recourse and non-recourse factoring together, often (but not always) acting as a non-recourse contract unless a specific condition is triggered – in which case recourse options may come to apply.
6. Shop Around
Comparison shop your options. Invoice factoring companies pay the bulk of what the invoices are worth up front (typically around 80-percent) with the remainder (minus fees) paid when all the factored invoices are paid.
Different options will suit different businesses and different types of invoices. An invoice factoring agreement that offers you a greater cash supply up front (such as 90-percent in the first payment) but that has less advantageous rates that draw from the second payment over time can suit a business with invoices to factor that are all due in the near future.
A business with invoices that will be paid in instalments or that won’t come due for a longer term may not find this same agreement works for them. Instead, they may favour an agreement that offers slightly less cash up front (such as 70-percent) but that draws less out of the second payment over the extended time they need.
Invoice factoring may sound complicated, but once you understand its mechanisms, it becomes a powerful tool. It can increase your operating or investment budget quickly and often with a more favourable fee structure than lending can. Take it step by step, and make sure the factoring company is willing to explain how the details work. The more you understand it, the more powerful it can become for your company.
- Set a target for how much money your business needs.
- Balance your short-term needs against long-term viability.
- Factor invoices from your most reliable customers first.
- Understand the details and fee structure in case something unexpected occurs.
- With these details in mind, compare the advantages of recourse vs. non-recourse factoring.
- Comparison shop your options, keeping in mind the strengths and needs of your business.