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When reviewing different types of financing options, it’s easy for a small business to wonder if invoice factoring is really worth it. (In case you’re new to invoice factoring, this is when a factoring company gives you funding for unpaid invoices ahead of net terms, and the waits for customer payments.)
Sure, it’s faster than traditional bank loans. But there is more to consider when choosing between traditional debt and alternative funding.
For example, some small business owners are hesitant due to fees associated with factoring, especially since the fee structure differs among factoring companies. Additionally, companies may be concerned about their customer’s perception of them for using factoring.
But your experience with the invoice factoring process depends on your funding partner more than anything else. Between an extensive range of options and common myths about accounts receivable factoring, it can make deciding on a finance option confusing.
Only you know what financing source makes sense for your specific business–but it helps to have all the information. That’s why we will break down the common use cases for using an invoice factoring service, dispel common myths, and explain what to look for in a quality invoice factoring company.
Should I use invoice factoring?
Most use cases for accessing cash through factoring invoices boils down to poor cash flow. According to the Service Corps of Retired Executives (SCORE), cash flow and costs are the top challenges faced by small and medium-sized businesses today. Furthermore, the average daily income for small businesses is just $7 above the operating line.
It would be impossible to invest and leverage growth opportunities with such limited cash flow. Even funding day-to-day business operations would be challenging.
A funding gap caused by unreliable cash flow is often the reason businesses seek out this form of financing. If you’re a B2B business and any of the below scenarios sounds like your current situation, you may want to consider factoring:
- Your business is growing.
- You have a big project coming up.
- You need to make payroll.
- Your business is seasonal.
- You need capital quickly for an unexpected expense.
- You want more cash on your balance sheet to end the quarter or attract investors.
All of the above are situations in which funding is needed to grow or remain in business, but cash flow challenges stand in the way. (See invoice factoring examples for how factoring helps in these situations.) And one of the benefits of factoring is steady, positive cash flow. But there are many others, too.
What are the advantages of factoring?
When deciding on the best business financing option for your situation, you will want to consider all the potential advantages. There are many pros for invoice factoring for small and large businesses alike.
Here are 5 questions to ask yourself to decide how invoice factoring measures up for you:
- Do you need funding quickly? A bank loan takes weeks, and sometimes months, to process, with no approval guarantee. In fact, bank approvals are in decline in the US. Meanwhile, working with a factor company can get you quick access to capital by funding invoices in a few business days.
- Do you need flexibility in when you can get funding? You may not always need funding, but lines of credit or business loans can help you navigate tricky business situations. The problem is that traditional forms of credit exclude many types of businesses (like new businesses), require stellar credit scores to pass credit checks, and take weeks to process. Even raising the limit on an existing line of credit can be difficult. With invoice factoring, you can get funded whenever you need it, and you can do it with no credit or bad credit.
- Do you want to retain ownership in your company? Non-dilutive invoice factoring ensures you never have to give up ownership in your company. But other forms of financing may require an equity stake. If you want to maintain complete control of your business but need fast funding, invoice factoring can be a solution.
- Do you want to avoid debt? If you’re already carrying debt, invoice factoring won’t add to it since your creditworthy customer pays the factoring company.
- Do you want to avoid long-term commitment? Once your client pays their invoice to the factoring company, the process is complete – depending on the factoring company. Some require long-term contracts, while others allow you to choose the invoices you want to fund. Make sure to look for this in any invoice factoring agreement.
What are disadvantages of factoring?
On the flip side, it’s also important to consider the disadvantages of receivable financing in the context of your business’ situation:
- Can be expensive. Invoice factoring rates vary a lot between 1% and 6%. Hidden fees can add up quickly, so you need to ask about any factor you’re considering to total factoring costs. Some examples of this are application fees, service fees, termination fees, transaction fees and other related costs. You’ll need to think about how much you’re willing to spend on factoring as you shop around.
- Business reputation. There can be a stigma attached to invoice factoring. The misconception is that the businesses using a factoring partner are in a bad situation financially, and many business owners worry about what their clients will think. But you should know that the opposite is often true: Business owners tend to use factoring to get funding for growth opportunities. In addition, many businesses, especially large businesses, and ones in industries where factoring is common (like staffing or oil and gas), redirect payment to factoring companies all the time.
- Concern over customer relationships. Some factors in the past left a bad impression by hounding their clients’ customers for payment, damaging valuable customer relationships. This understandably worries business owners, since collecting payment from customers is a delicate process. (You can see how we treat your customers if this is a concern.) This is a critical point to investigate when you’re reading reviews and talking to different factoring companies.
- Difficult to account for in bookkeeping. It can be confusing to record factoring transactions in your books accurately. Many accountants and bookkeepers aren’t familiar with how to add factoring transactions into their payment process. The good news is that it isn’t as complex as it appears. Our step-by-step guide can help. It’s specific to Quickbooks, but the basic principles apply to any accounting software.
These concerns are valid, but many of them are larger-than-life myths. The cost of factoring doesn’t have to be expensive, and it doesn’t have to affect your customer relationships. It takes a little leg work, but you can find factor rates that make sense for your company and an invoice factoring company that collects payment from customers professionally.
How to Choose a Partner that Will Make Factoring Worth It
Finally, if you’re looking for the answer to whether factoring is worth it, it depends on the factoring firm you choose. You can get a detailed comparison of several factoring companies in our best invoice factoring companies post, but here are the highlights:
- Cost. This isn’t just about the discount rate – the percentage the factoring companies keep as their factoring fee – it also includes hidden fees. Make sure you understand the entire cost for any company you’re considering.
- Advance rate. This is the amount the factor advances you. Some companies only advance 80% to 85% of an individual invoice and give you the rest once your customer has paid. (FundThrough advances 100% of your invoice less our fee.)
- Speed. One of the most important advantages of factoring is that it’s fast. Make sure any company can give you an advance in days, allowing you to resolve immediate cash flow issues quickly.
- Application process. The funding process should be short and easy so you can get back to business. What makes a fast application process? Technology. For example, FundThrough uses AI, automation, and integrations with accounting platforms like QuickBooks and OpenInvoice to eliminate time-consuming paperwork and make faster decisions.
- Freedom to choose invoices. Some factoring companies make you commit to factoring all your invoices for one customer or to funding a minimum dollar amount every month. If you think you’ll need funding regularly, this might not be a problem for you. However, other factoring companies let you choose which invoices you want to fund with no minimum monthly funding requirements (like FundThrough).
- Dedicated customer service. It can help to have an account manager who will help you through your first funding and get to know you and your business over time, so that they can help you with future funding needs. Be sure to ask any factoring company you’re considering about their level of customer service.
Is invoice factoring worth it? The bottom line
In short, invoice factoring can be a helpful solution for small businesses in need of faster access to working capital. With the right partner, you can take advantage of this alternative financing option to close gaps in cash flow, leverage growth opportunities, navigate extended payment terms, and strengthen your financial position – all by turning invoices into cash.
By weighing the pros and cons carefully, you can determine whether or not invoice factoring is the best option for your business’s needs.
If you think invoice factoring is worth it, see if you qualify for FundThrough.