Learn More About This Type of Flexible Business Funding
If your business is expanding, you might be experiencing cash flow issues, and this situation is far from an uncommon problem.
An expanding business needs the cash from its sales to fund the next round of purchases. But when sales invoices are outstanding for 30, 60, or even 90 days, cash flow can be tight for a growing enterprise.
If your sales are growing, but you lack the cash to fund expansion, you might have considered factoring as a solution. But like any financing option, there are cons as well as pros to sales invoice factoring. So, here are the main advantages and potential drawbacks of factoring to help you decide if it is right for your business.
How Factoring Works
Sales invoice factoring, also sometimes known as accounts receivable financing, is a well-established financing tool for small and large businesses.
When you factor sales invoices, a factoring company advances money due from your accounts receivable. You send copies of your invoices to your factoring provider. The factoring company will then pay you a percentage of the cash due from those invoices. Your customers pay the factoring company instead of you. And the factoring company pays you the balance of the invoices. A factoring fee is deducted from the amounts paid to you.
The Benefits of Factoring
Sales invoice factoring is a simple way to release the cash tied up in your accounts receivable. But factoring may not be suitable for all types of business. However, first, here are the significant benefits to be gained from factoring.
Maintains Positive Cash Flow
Companies that factor their invoices receive most of the cash from sales invoices within 24 hours. Accounts receivable accounts are paid much faster, increasing the working capital available in the business to fund growth.
Speeds Up Full Settlement of AR Accounts
The factoring company does not pay the balance of factored sales invoices until the customer settles the invoice. However, factoring companies employ professional collections staff to chase outstanding invoices. And the best factoring providers are well-respected companies. In general, you will find that customers settle their invoices in full faster when they are dealing with a factoring company.
Reduces AR Admin Costs
A factoring company will manage your accounts receivable for you. For example, your factoring provider will carry out credit checks. And the factoring company will chase overdue accounts for you. You’ll no longer be faced with the AR management headaches along with the associated costs.
Related: How Much Are Your Accounts Receivable Costing You?
Simplifies Financial Planning
Knowing that sales invoices will be paid almost immediately greatly simplifies cash management and financial planning. A company can confidently predict future income, making it less challenging to schedule purchases and payments. Indeed, factoring can save a business a massive amount of time that would otherwise be spent on updating forecasts and juggling vendor payments.
Reduces or Eliminates Bad Debts
Depending on the type of service you apply for, factoring can reduce or eliminate the risk of bad debts.
If you enter a recourse factoring arrangement, you are responsible for bad debts. Suppose a customer fails to pay an invoice within a reasonable amount of time. In that case, you will be required to repay the factoring company monies advanced against that invoice. However, a factoring company will usually credit check all your customers, reducing the risk of bad debt.
If you decide to use non-recourse factoring, the factoring company bears the risk of bad debts. In most scenarios, the risk of bad debts will be eliminated.
Flexible Form of Finance
Factoring is one of the most flexible business finance options around, and it is that flexibility that makes factoring an extremely useful financing tool for expanding businesses.
The amount that you are advanced when you factor sales invoices varies as your turnover does. So, as the business expands, you have access to more funds right when needed. However, if sales tail off in a month, the amount advanced reduces along with the associated factoring fees.
Does Not Impact Ability to Borrow from Other Sources
Factoring companies do not lend their customers money. Instead, they buy a company’s sales invoices at a discounted value. That means that there is no loan to pay off and no liability recorded in the balance sheet. While the positive effect on cash flow can be significant, factoring does not affect a company’s ability to borrow from other sources.
Related: Ten Benefits of Invoice Factoring for Small Business
The Disadvantages of Invoice Factoring
Of course, it would be misleading to suggest that are no drawbacks to sales invoice financing, and factoring may not be the answer for every business. Here are some of the potential disadvantages of sales invoice factoring to consider before applying for this type of funding.
Not Suitable for Cash Sale Businesses
Factoring will only benefit companies that raise credit sales invoices. Retail business, for example, would not be able to use factoring. In addition, companies that sell on a cash-with-order basis or offer only short periods of credit are unlikely to benefit from invoice factoring.
Costs
There are, of course, costs involved in factoring. There will be an interest charge on outstanding invoices. There may also be some charges associated with the administration of the factoring account.
Loss of Control of AR Collections
Generally, factoring companies take responsibility for collecting the outstanding sales invoices on behalf of their customers. Some see this AR management aspect of factoring as a loss of control. However, the best factoring companies work with their customers to collect overdue debts and don’t employ heavy-handed collection practices.
Customer Acceptance Concerns
Another concern of some people is that factoring companies dictate with whom their customers can do business. Indeed, factoring companies usually check the creditworthiness of customers before they advance any money. However, in most cases, you do not have to factor all your invoices. Suppose you decide to do business with a customer rejected by your factoring provider. In that case, that is a decision you are free to make.
You Are Liable for Bad Debts
As mentioned above, there are two types of factoring arrangements: recourse and non-recourse. Your company will be asked to refund the factoring company for any bad debts incurred in a recourse arrangement. In a non-recourse factoring arrangement, the factoring company will bear the cost of most bad debts. However, as you would expect, non-recourse factoring is more expensive than the recourse alternative.
Canceling a Factoring Arrangement
Factoring agreements can, of course, be canceled with the required notice. However, should you decide to stop factoring your invoices, you will lose the benefit of receiving immediate cash from sales invoices. So, you will revert to funding your accounts receivable out of cash reserves. This funding gap can sometimes lead to the need for alternative financing should you decide you no longer want to factor your sales invoices.
Related: 10 Considerations When Selecting the Best Factoring Company for Your Business
The Bottom Line
To sum up, factoring provides a flexible financing solution for expanding businesses that issue credit sales invoices. And, for most companies, the benefits outweigh the disadvantages. However, it is best to always go into any financial arrangement with all the facts. So, hopefully, the above will have helped you decide if sales invoice factoring is right for your business.
Your Questions Answered Quickly
Whether your business is thriving and you can’t keep up, or you are waiting on clients to pay, Universal Funding can help your growing company. Call us at 800.405.6035 or complete our rate form today to learn more about invoice factoring and how it can improve your company’s cash flow.
About Universal Funding
Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.
