Many businesses experience problems with their cash flow. If you need instant funds to fund expenses in your business or to boost working capital, invoice factoring is one of the best options for you. It is basically an account receivable financing that most business owns use to get funding. How does it work? With invoice factoring, the invoices are converted within a certain period of time into cash. The factoring company will pay you in installments. You get to have a cash advance amounting to 80% of your outstanding invoices and the rest will be paid once the invoice is paid. The factoring company will deduct the fees based on the fee structure both parties agreed on.
For many, especially those who haven’t tried it before, they make mistakes which make the whole experience unpleasant and not to mention, expensive. First things first, it is very crucial that you know how invoice factoring works, what it actually is and what it is not.
How Does It Work?
The following details the steps for invoice factoring.
After providing products or services to your clients, you issue an invoice to your customer. Usually, this will take them around 30 to 90 days to pay. In order for you to qualify for factoring, the invoices need to be payable within 3 months or 90 days.
Since your funds are tied with up with the invoice, you either have to wait until such a time the invoice is paid or you have the option to sell the invoice to a factoring company. When you sell your outstanding invoices, once approved, you get to have the funds you need.
The factor will then pay you in advance. The initial advance that you get is known as the advance rate which is usually about 80% of the invoice. This will depend on several factors including the transaction itself and industry.
After the time stipulated in the invoice has lapsed, your client will then pay the factor.
Once the payment is settled, the factoring company will pay the remaining balance. They will deduct the fees.
How to Qualify
Before you can have your invoices factored, you need to qualify first. Unlike other kinds of loans, it is relatively easier to qualify for invoice factoring. Credit scores, revenues, and other factors can hurdle business owners to qualify for a certain kind of financing, these are not often the main things that invoice factoring companies consider.
However, it is important to note that there are primary factors that they still do consider which include the following:
When you issue invoices to your customers, it is very important that your clients are established businesses as well and have good credit standing. At the end of the day, factor companies take into consideration as to whether the customer will be able to pay the invoice.
The invoices issued must be payable within 60 to 90 days.
Your business is legitimate and you don’t have any history of legal problems.
There are some factor companies that require a minimum credit score.
Now, that you are more or less familiar with how invoice factoring works, let’s discuss the different mistakes that most business owners make and how to avoid them.
Mistakes to Avoid
Not choosing a reliable factor company
Just because you need instant cash, you will sell your invoices to the first-factor company you saw without taking the time to delve into the company’s profile. Keep in mind that in order for things to work out and to have a pleasant experience with factoring and in order not to have any problems with your customers, it is very essential that you find an established factor company that you will work with.
Failing to completely understand and read the terms and conditions
Since you will be selling your invoices to a factor, you need to have everything in a written agreement. On your part, you need to read the agreement. Make sure that you understand the terms and conditions of the contract. You need to check their fee structure and see if there are missing parts about the fees. The last thing you would want to happen is to be surprised with fees that you are not even aware of.
Not understanding how it all works
Factoring has been used as a financing tool for years. For most business owners, it will still take some time to fully understand how it works. One of the errors that businesses make is when they misdirect payments. Once you sell your invoices, you shouldn’t be receiving the payments. The factoring company should receive the payments.
You need to have a new bank account and you need to tell your clients which bank account they should send the money to. Miscommunication often occurs and unfortunately, this can cost you. Not only that, you don’t want to strain your relationship with the factoring company.
Using a purchase order
Submitting purchase orders are not allowed. Most don’t understand that a purchase order cannot be factored in simply because they don’t come with revenue. With a purchase order, you buy products or services and wait for them to be delivered. In order to save time, it helps that you know which specific invoices can be factored in and which ones are not.
Thinking that it is very easy to qualify for invoice factoring
Although it is considered to be relatively easier to have your invoices factored than going through traditional loans, it does not necessarily mean that you can get 100% approval and it will not take any paperwork. Factors will still require you to submit documents on top of the outstanding invoices. One mistake that several people commit is that they fail to take into consideration the amount of time needed to do the paperwork. In reality, the time that you have to spend dealing with all of these things is still an opportunity cost that you have to consider.
Not knowing the different types of factoring
There are various types of factoring and you should know what are these and how they differ. It actually depends on what your business needs. You can either go for invoice factoring or invoice financing. This enables you to have flexibility and to get the best financing option for your business. If you want to have more flexibility, you should opt for invoice financing. They don’t buy invoices; they use the invoice as collateral. This is the other way around with invoice factoring.
Making invoice factoring the only means to finance a business
There is no doubt that invoice factoring is a great way to get funding really quick. And although you might think that this is the best and easiest way to get the money you need, it is not always the case. If you have a good credit standing, there are numerous financing options that you can choose to have. You need to be able to weigh the different options so you can assess which financing option best meets the needs of your business.
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