The Pros and Cons of Invoice Factoring: Is Factoring Right for Your Business?
Invoice factoring offers businesses a variety of benefits, including increased cash flow without taking on new debt or using up available credit. However, there are also disadvantages, particularly the fees charged, which may eat into your business's profits. Determining whether invoice factoring is right for your business requires taking a clear look at what it involves and your company's unique needs. Ultimately, only you can determine whether the pros outweigh the cons.
The Pros of Invoice Factoring
Some of the benefits of invoice factoring are obvious, such as the increase to your available cash, while others are less obvious but no less important.
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- Cash flow: This is probably the main reason most companies even consider invoice factoring. As soon as you send your customer an invoice, you can then send that invoice to your factor and receive payment, usually within 24 hours. This improved cash flow allows you to cover your own operating costs, invest in improvements, work through a rough spot, expand more quickly, or do any of the other things your company might want to do with an increased cash flow.
- No extra debt: If your goal is reserving your credit for capital improvements or expansion, you don't want to increase your cash flow at the expense of taking on more debt. Invoice factoring is not a loan but an advance on the money your customers already owe you.
- Quickly access funds: The process to acquire a traditional loan typically takes weeks, including completing the application, obtaining approval, and finally accessing your funds or new line of credit. Invoice factoring puts money into your bank within hours of the factor accepting the invoice.
- Flexibility: The best factoring services offer flexible terms that lower your rates as the amount that you invoice increases. You may also be able to choose which customers and invoices to factor.
- No credit, no problem: Your factoring company is more concerned with your customers' creditworthiness than yours. That means that, even if your business is new or has little credit, you can still improve your cash flow. Banks, of course, are more concerned with your credit and, if there isn't much there yet, you won't get the best rates.
- Professional collections: The factoring company wants your customers to pay their invoices as much as you do. That's why they employ expert, well-trained collections agents to track down payments. This saves you the hassle and expense of hiring a collections agency to perform the same task.
- Purchasing power: If you can pay cash instead of using credit, you often get better rates from your own suppliers. You can also take advantage of discounts offered for paying invoices early.
- Spend your money as you wish: The typical bank loan or line of credit carries certain stipulations on how those funds may be spent. Since invoice factoring is just paying you the money you've already earned, you get to spend it in whatever way benefits your business the best.
- Take on new work: Sometimes, an influx of cash is all it takes to be able to take on that new, big project. Unfortunately, smaller companies and startups often lack the resources to fund the cost of a new project or job until their current accounts receivable are paid. Invoice factoring often gives your finances the little boost they need to take on that new job.
- Value-added services: Many factoring companies offer extra perks, such as credit reports on your customers and free ACH payments. You may also enjoy industry-specific benefits, such as discount fuel cards for transportation companies.
The Cons of Invoice Factoring
Though there are numerous benefits, there are some disadvantages with invoice factoring, chief among them the cost.
- The costs and fees: Factors charge a fee for every invoice they process, and the fee increases with the amount of time it takes your customer to pay. They may also charge additional fees, such as processing, or a penalty if the customer doesn't pay on time. Look carefully at the fee structure and compare it to the interest you might pay for more traditional financing to determine whether this is the best option for your company.
- Contracts: If what you want is a quick, short-term fix for a cash flow issue, you may be better off not entering into an invoice factoring agreement, particularly if the factor insists on a long contract. Some offer contracts as short as six months, while others may extend to three years, though you can usually negotiate contract length. Again, consider your needs carefully before signing anything.
- Managing your reputation: Some clients may question the health of your business if you turn to invoice factoring, and there's no hiding the decision, since payments usually go to the factor, not to you. You can explain your reasoning to your clients, but it may still alter perceptions of your business.
- Sharing control: Since many factors collect invoice payments, you need to make sure its business practices are ones you consider fair and ethical, as they represent your business in their collection efforts.
- You have to rely on your customers' credit: Your rate, and the factoring company's decision whether to approve a customer, depends heavily on your clients' credit rating. This is something you have zero control over.
Is Invoice Factoring Right for Me?
Consider all of these items carefully to determine whether the advantages outweigh the disadvantages. Factoring offers a variety of benefits over securing credit or a loan through a bank, but if you don't take care when negotiating, you may wind up paying more than you would have with a traditional loan. Luckily, you have many options available to you, so finding a factoring company that fulfills your needs shouldn't be difficult.