The pros and cons of a financing tool businesses use to get cash fast for unpaid invoices.

Cash flow is the life blood of every business. Business owners need to keep money coming in so they can pay for everything from rent and supplies to payroll and insurance. However, when customers take 30, 60 or even 90 days or more to pay, the rate of incoming cash might not match the pace of money going out. When this happens, some businesses use invoice factoring to speed up the flow of incoming funds. Here’s a quick overview of how invoice factoring works and its pros and cons.

What is invoice factoring?

Businesses that use invoice factoring (sometimes called accounts receivable factoring) sell unpaid invoices to a third party—a factoring company–for cash and at a discount. The discount is usually between 1% and 5%.

Whether the company selling the invoices or the factoring company handles collections depends on their agreement.

Pros of invoice factoring

The key advantage of invoice factoring is that the business selling invoices gets cash fast.

If your terms with the third party are for non-recourse factoring, the invoice factoring company is responsible for collections and unpaid invoices. Not having to handle collections frees up resources for other priorities, like innovation and growth.

Some business owners also like that invoice factoring brings in cash without going into debt or putting their equity up for collateral.

Cons of invoice factoring

A significant disadvantage of invoice factoring is that it costs more than other credit solutions, such as a business line of credit. Plus, additional fees can take an even bigger bite out of profits.

A potential disadvantage when using a factoring company is that the behavior of the factoring company when it comes to collections could strain or sour your relations with your customers.

If the agreement with a factoring company is for recourse factoring, the business selling the invoices will be on the hook financially for unpaid invoices. This means paying back the money that the factoring company paid in advance.

Additional consideration for invoice factoring

Your ability to sell invoices to a factoring company will depend on the creditworthiness of your customers.

Also, factoring companies are usually only interested in accounts receivable from commercial businesses and government agencies.

If you opt for invoice factoring, be sure to thoroughly vet the provider and understand the terms in their entirety. Delve into fees, the company’s track record and reputation, funding limits and how fast funds are provided. Shop around and compare several companies.

 

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