How To Use Invoice Factoring to Finance Your Business When Waiting for Invoices to Come In
If you own a business that relies on customers paying their invoices for you to operate, you know that slow-paying clients could cause issues for your entire operation. Luckily, there are financing options for your situation. If you need working capital quickly, consider invoice factoring.
How It Works
When you apply for a traditional loan, you receive a lump sum under the agreement that you will repay a certain amount each month until you’ve paid back your loan with interest. While invoice factoring has some of the same components, it is actually quite different from a traditional loan. In fact, instead of using your assets as collateral, you’re simply selling them. You’ll still receive a lump sum, but instead of paying interest, you’ll pay a percentage of the invoice as a fee. This means you never need to worry about losing your business or otherwise finding yourself in financial dire straits because you can’t pay back a loan.
What the Buyer Does
When you decide to sell your invoices, the lender purchases them based on providing you with an advance. For example, if a client owes you $20,000, the buying company may choose to give you 80 percent of that ($16,000). You’ll pay a fee of up to 5 percent ($1,000) as well. This leaves $3,000, which you’ll receive from the buyer once the client pays the invoice.
Pros and Cons of Selling Invoices
Like any type of financing, factoring as advantages and disadvantages. On one hand, selling your invoices gets you fast cash and is easier to be approved for if your clients have good credit but your business does not. Additionally, it may even save you time since the buyer takes over contacting any clients who fail to pay and leaves you free to handle other tasks. On the other hand, the fees for selling invoices can become quite expensive if you intend to sell many of them, and if your clients have weak finances, you may not find a buyer. Finally, since you lose direct control over contacting late accounts, it is important to ensure the buyer uses ethical practices when dealing with them.
Overall, invoice factoring is an excellent choice if you need fast cash and don’t have the financial background to take out a traditional loan. However, it should be used only when needed. If you can afford to go the traditional route, it is probably best to do so.