The Pros and Cons of Business Invoice Financing
Contrary to popular belief, business invoice financing is not a business loan, but rather an advance against your business’ pending invoices – money your customers already owe you. Through this process, you sell your outstanding invoices to a factoring company, and the factor will pay you a lump sum – typically 70%-90% of the total value of your invoices. Once received, the funds can then immediately be used as working capital. The factoring company collects payment for the invoices and typically charges a small fee for the services rendered.
There are many reasons why business owners apply for invoice financing, but just like any other type of financing, it has its own set of pros and cons.
Pros of Business Invoice Financing
Higher Rate of Approval: Unlike traditional business loans, credit score, loan history, and collateral are not major determining factors for invoice factoring. The pending invoices act as collateral, which means the factoring companies are more concerned with your customers’ payment history, as opposed to yours.
Outsourcing: Keeping track of your invoices and contacting customers can be taxing. With invoice financing, the factoring company will be the one to keep track of your invoices, leaving you with added time to focus on more important tasks.
Continuous Cash Flow: As long as your business has pending invoices, you can continue to use invoice factoring. Instead of waiting months to receive payment on outstanding invoices, you can receive the money on your terms which enables you to maintain steadier cash flow.
Immediate Cash Flow: The process of applying for traditional business loans is long and tedious – sometimes it takes months before you’re approved. Invoice factoring offers immediate access to cash, ensuring your business operations continue to run smoothly.
Grows with Your Business: Unlike traditional term loans that only offer a one-time solution, your invoice financing line increases as your business grows. The invoice financing line is tied to the value of your invoices. As a result, it can easily increase as your invoices increase in value, given that your clients remain creditworthy. This financing option is great for rapidly growing companies needing financing to keep up with the rate of growth.
Cons of Business Invoice Financing
Customer-Reliant: Lenders may not be too particular about your business’ financial history, but they will take your customers’ payment history into consideration before approving your application. Therefore, if your customers have a bad payment record, it could negatively impact your chances of having the factoring company take on your invoices.
Fees: Factoring companies typically charge around 1% to 5% of your invoice’s total value. Before you consider invoice financing, you need to determine whether fast access to capital is worth the fees.
Liability: If your customers default on their invoices, you may be held responsible. Factoring companies are not collection agencies, which means they won’t waste their time tracking down your customers who fail to pay on time. If you’re in a recourse invoice factoring agreement, you’ll bear the burden of paying for those invoices. Some factors may allow you to trade one invoice for another of the same value, but that is dependent upon the factor.
Handling Bad Debt: While financing companies take on the responsibility of collecting payments from your customers, they are not a collection agency. If a customer does not pay his/her invoice, you will be held responsible for it. Bad debt will go back to your company and if this happens, it’s best to consult an attorney or a collections agency.
Limited Control: As mentioned, invoice financing companies assume complete control over your invoices. While this isn’t a problem for many, some business owners are not comfortable having another company handle their finances. Before you apply for invoice financing, you need to assess potential factoring companies and ensure that you’re truly comfortable with them handling your invoices.
Is Invoice Financing a Better Option for Your Company?
The answer depends on the type of business you run and the number of invoices you process. Invoice financing can greatly benefit small businesses that need funds quickly. To determine whether this financing option is suitable for you, you need to assess your business.
If your late-paying customers are negatively affecting your cash flow and you don’t have enough funds to take on new projects, invoice financing may be a better option for your company. To qualify, you need to ensure that your customers are creditworthy and they have a history of on-time payments. More importantly, you need to know for sure if you are financially capable to pay for the fees that come with invoice financing.