Sooner or later, every business must endure the stress and frustration of the non-paying customer. When a customer fails to pay, not only is your bottom line affected, but you are rendered unable to meet your financial obligations, which can cause large amounts of unnecessary stress. As with any aspect of a business, thorough business planning can help you deal with this situation if and when it arises. Invoice factoring is one way to ensure steady cash flow.
A Contractual Relationship
Invoice factoring arrangements are contracts which allow you to sell any current outstanding invoices less than 90 days old to an invoice factoring company. The relationship in this scenario is that you are a borrower, because you receive a cash advance from the factoring company. You can be advanced up to 80% of the total amount owing, and will need to pay fees and interest on the amount you borrow.
One thing to consider before working with any invoice factoring company is their fee structure. This involves asking about advance rates, discount rates and setup fees. Your fees will be determined by the creditworthiness of customers and total accounts receivable, and not your personal credit history.
It’s important to ensure that all fees are specified in the contract with a factoring company before you sign. If a company is offering rates that are lower than anywhere else, this may be a reason to be concerned.
A stated earlier, an agreement with an invoice factoring company is one that identifies you as a borrower. As such, collateral may be required. However, this will depend on whether or not you are requesting an advance rate that’s higher than usual, or may be applied if you are doing business with a factoring company for the purposes of trade finance.
Collateral may also be required if the factoring company discovers that one or more of your customers has a weak credit history, but you still wish to add those invoices to your factoring contract. In this scenario, collateral would be required in the event that the customer doesn’t pay. Forms of collateral can include anything from a direct pledge of some sort to real estate.
You can opt for a limited contract, especially if you are dealing with a factoring company for the first time. This will help you avoid the uncomfortable situation of having to deal with a company that isn’t right for you and your business needs. Any short-term contract can be extended if you find that the company you’re dealing with does what you expect them to do.
It’s important to know whether a factoring company is doing their work on a recourse or non-recourse basis. Factoring done on a non-recourse basis means that the company is providing credit protection for your receivables in the event that your customers don’t pay. This scenario can cost more in terms of fees, but it also eliminates any collections issues.
In general, good candidates for invoice factoring are those businesses which have a good trading history and are of a low investment risk. A low investment risk business is one who spreads its financial risk over several, and not just one or two customers. You may also be required to have clients who pay their invoices on time for the most part.
Where raising an invoice may take you as a business owner as many as 90 days or more, a factoring company can get you the money you need in 24 hours or less. Going with a factoring company is a great way to improve your business’s cash flow, as well as pass on the stress and frustration of hunting down payments to a company who has made this its business.