You may already be familiar with some benefits of factoring, like how it provides fast access to cash and how most companies qualify, even if they don’t make the cut for traditional loans. These things are true but don’t paint a complete picture. On this page, we’ll go over some of the benefits of small business factoring that aren’t often discussed so you can get a better feel for how it works.
Invoice Factoring for Small Businesses: The Basics
Factoring turns your unpaid invoices into working capital you can use right away. Instead of waiting weeks or months for your client to pay, you sell your invoice to the factoring company as soon as goods or services are delivered. The factoring company immediately sends you most of the invoice’s value and then sends the remaining balance minus a small factoring fee when the client pays their invoice.
It’s distinct from financing options because it’s not a loan. There’s no money to pay back because your client owes the cash. It’s also different from most business loans because invoice factoring companies work with most businesses. Your client’s credit matters more than yours, so approval is fast and easy.
Sometimes, people associate it with other funding methods that provide a cash advance based on outstanding invoices, such as a merchant cash advance (MCA) or invoice financing. However, it’s different from these, too. An MCA is a loan that uses your credit card transactions as collateral. A percentage of your sales is held back each day to cover the loan and fees until it’s paid off. Invoice financing is a loan offered by an invoice financing company that leverages your invoices as collateral. You pay the balance and fees when your client pays their invoice.
5 Often Overlooked Benefits of Factoring
Now that we’ve covered the basics of invoice factoring services, let’s look at some of the often overlooked benefits.
1. Your Business Credit Score May Improve
Lots of things depend on having a good business credit rating. For instance, you need strong credit to qualify for a bank loan. Insurance companies will often pull your credit report before offering coverage and to determine your rate. Bad credit can disqualify you from receiving trade credit or renting a property, too.
The things that influence your business credit score are similar to those that impact your personal score. For instance, credit bureaus look at your payment history, collections, and liens, as Experian reports. The amount of debt you have and credit utilization matters as well.
These are all influenced by factoring. For instance, it’s not a loan, so it keeps your debt ratio lower. It also provides a cash injection, which can keep your payment history strong and avoid issues like collections actions and liens.
2. Your Financial Risks Reduce
A typical company writes off 1.5 percent of its receivables as bad debt, according to TSI. That means if your business invoices $500,000 annually, $7,500 will be uncollectable. Some businesses struggle more, and some have far less bad debt. Where you sit on the spectrum hinges primarily on two things: the creditworthiness of your clients and how much credit you extend to each.
Because your clients are responsible for paying the factoring company, and factoring companies are experienced at assessing risk, they address these areas. One of the first things your factor will do is perform a credit check on your client. That way, you know exactly how much credit you can safely extend to any client. Secondly, they consider the concentration of debt. They evaluate your total receivables and help identify how much debt a company can owe at any given time without exposing your business to unnecessary risk. For instance, if your total monthly revenue is around $40,000 and $30,000 is owed by one client, your business might not survive if that client doesn’t pay. Giving one client that much control over your cash flow is too risky.
You ultimately decide who you want to work with and how much credit you want to extend, but your factoring company won’t accept invoices for processing that exceed the thresholds that they’ve established to help minimize your risk. If you follow their recommendations and don’t extend credit when it’s risky, you’re likely to see a drop in bad debt.
3. You Get Some of Your Time Back
Factoring companies take care of all kinds of back-office processes. For instance, they handle the collections process, so you no longer have to chase invoices. Some offer invoice preparation services, too. A few also offer 24×7 account access, allowing you to pull reports and see where all payments are at any time. And, of course, if you’re already performing credit checks, your factoring company will take care of that for you, too.
More than two-thirds of businesses spend 14 hours per week on administrative tasks related to collecting payments, according to Intuit. If you allow your factoring company to take care of this for you, that’s almost seven days your business gets back each month.
4. Increased Financial Flexibility Allows You to Improve Your Reach
Have you ever turned down work because you couldn’t afford the associated expenses or couldn’t wait for payment? Or, have you ever been unable to pivot quickly enough to seize an opportunity, such as purchasing a competitor or reaching a new market due to limited working capital? These things happen all the time. Unfortunately, you’re not just shortchanging your business growth when this occurs. You’re losing market share because those customers or opportunities are going to your competitor. The more opportunities you miss, the less likely you are to be able to catch up and compete.
Most forms of funding aren’t designed for these situations. They take weeks or months to pay out and have rigid qualification criteria. Invoice factoring doesn’t have the same criteria. Plus, you can qualify for factoring within a couple of days and even get funded as soon as the day you submit your invoice.
5. Predictable Cash Flow Makes Financial Planning Easier
It’s often challenging for small businesses to predict cash flow. This is because something as simple as a single slow-paying customer can derail anticipated inflows, or an emergency expense can send outflows skyrocketing. However, you get paid right away with invoice factoring. That makes it easier to budget and spot potential shortfalls before they become a problem.
Get a Complimentary Small Business Factoring Rate Quote
If invoice factoring sounds like your ideal cash flow solution, we’re happy to connect you with a factor that specializes in your industry and offers competitive rates. Request a complimentary rate quote to get started.