Cash-flow issues are common, even if you run a profitable small business. This is especially true when you need cash right now but have customers who won’t pay for goods or services until later.
One solution to the cash crunch is invoice factoring.
With invoice factoring and its closely related counterpart, invoice financing, you can turn unpaid invoices into needed funds. Here’s what you need to know:
- What factoring companies can do for you
- Invoice factoring example
- Invoice factoring pros and cons
- Invoice financing and receivables-based line of credit
- Where to find factoring companies and financing options
What factoring companies can do for you
Invoice factoring and invoice financing are options for B2B companies — those that sell goods and services to other businesses. It’s a way to manage cash flow when you have slow-paying customers, and it lets your business convert its account receivables — the money owed by customers that has not yet been paid — into immediate cash.
Technically, invoice factoring is not a loan. Rather, you sell your invoices at a discount to an invoice factoring company in exchange for a lump sum of cash. The factoring company then owns the invoices and gets paid when it collects from your customers, which typically happens in 30 to 90 days.
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An example of invoice factoring
Let’s say you own a hardware store and sell goods to another business, creating a $10,000 invoice. This particular company has an agreement to pay off its invoices in 30 days, but you need the cash next week to pay your employees, creating a cash shortfall. You could turn to a traditional bank for a loan, but it likely requires collateral (a physical asset, such as real estate, which can be sold by the lender if you default) and stellar personal credit. Or maybe you qualify but can’t wait several months for the loan to close.
So you turn to an invoice factoring company, and it agrees to buy your invoice for $9,700 in cash — $10,000 minus a 3% factoring fee ($300). The invoice factoring company advances 85% (or $8,245) of the invoice within a few days (although the actual size of the advance will depend on numerous factors, including the total amount of the advance, the age of the invoice and the customer’s creditworthiness). The factoring company then collects the invoice when it’s due and advances the remaining balance owed to you ($1,455).
|Initial advance (85%)||$8,245|
|Remaining advance (12%)||$1,455|
The factoring fee, also known as a discount rate, can cost from 1% to 5%, depending on the invoice amount, your sales volume, your customer’s creditworthiness, and whether it’s a recourse or non-recourse factor, which refers to who is ultimately responsible for an invoice that goes unpaid — your company or the factoring company.
If the contract is a recourse factor and the customer doesn’t pay, you may have to buy back the unpaid receivable from the factoring company or replace it with a more current receivable of equal or greater value. If it’s a non-recourse factor, you’re under no obligation to repay or replace the unpaid receivables, but you’ll likely be charged a higher transaction fee because the factoring company takes on the added risk of not getting its money back.
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Invoice factoring pros and cons
- Fast cash: Invoice factoring can provide immediate working capital to help cover a funding gap caused by slow-paying customers.
- Easier approval: Invoice factoring provides financing to companies that might not be able to get capital from other sources, such as traditional banks, because of a lack of collateral for a loan, poor personal credit or a limited operating history. Invoice factoring companies typically only care about the value of the invoices you are looking to factor, as well as the creditworthiness of the customers.
- Improved cash flow: You can keep loyal customers on longer payment terms. This feature can improve your cash flow and help you grow your business.
- Costly: The service can be quite expensive. You have to watch out for hidden fees, such as application fees, a processing fee for each invoice you finance, credit check fees, or overdue fees if your client is past due on a payment, which can bump up the annual percentage rate (the annual cost of borrowing money with all fees and interest included).
- Loss of direct control: Because the invoice factoring company may collect on the invoices directly, you need to make sure it is ethical and fair when dealing with your customer.
- Customer’s bad credit could derail your financing: The factoring company may need to verify the creditworthiness of your customer. If the customer has a history of late or missed payments, you may not be approved for the financing.
Invoice financing and receivables-based line of credit
Invoice financing is a bit different from factoring in that you aren’t selling your invoices to a factoring company. Instead, you use the invoices as collateral to obtain a cash advance and are responsible for collecting the invoices yourself.
A receivables-based line of credit is another invoice financing option for small businesses. This short-term line of credit is secured by the borrower’s unpaid accounts receivable. It’s structured as a credit line instead of a purchase of your accounts receivable. It works like a credit card: You get access to a sum of money and decide how much to borrow and repay.
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Where to find factoring and invoice financing options
Small businesses can turn unpaid invoices into fast cash with factoring companies, including online lenders. The terms, rates, speed of funding and qualifications differ for each lender; we compare them below.
BlueVine is one option for invoice factoring. The alternative lender advances 85% of your invoice amount upfront and the rest when a customer pays you (which can be anywhere from one to 12 weeks), minus fees of 1% per week. BlueVine’s APR on invoice factoring ranges from 17% to 60%. Readers should note that BlueVine requires you to set up a new bank account and a P.O. box for your customer’s payments.
Before you apply for BlueVine’s invoice factoring, find out whether you meet the minimum qualifications.
Do I qualify? ▾
Fundbox is an invoice financing company that advances 100% of the value of the invoice upfront, and you repay it in 12 equal weekly installments, plus a fee. You can borrow from $500 to $100,000, with funding in one to three business days. It’s a good option if you have bad credit or want to avoid a credit check, or if you need to finance a smaller amount from your invoices.
Before you apply for Fundbox’s invoice financing, find out whether you meet the lender’s minimum qualifications.
Do I qualify? ▾
Online lender Dealstruck’s asset-based line of credit lets you borrow up to 85% of your outstanding invoices up to $500,000. You only pay interest on the amount you’ve borrowed. Each draw is repaid over a period of six months. Dealstruck also requires your customers to send payments to a new bank account that Dealstruck sets up in your name.
Before you apply for a Dealstruck loan, find out whether you meet the lender’s minimum qualifications.
Do I qualify? ▾
Find and compare the best small-business loans
If invoice factoring is not for you, check out other financing options on NerdWallet’s small-business loans page. We gauged lender trustworthiness, market scope and user experience, among other factors, and arranged them by categories that include your revenue and how long you’ve been in business.
Compare business loans
This article was updated June 22, 2016.
Steve Nicastro is a staff writer at NerdWallet, a personal finance website. Email: Steven.N@nerdwallet.com. Twitter: @StevenNicastro.