Is invoice financing risky?
We understand why you might be asking, “is invoice financing risky”? After all, we all want to avoid making a bad financial decision for our business. One wrong move and you could be out hundreds if not thousands of dollars, which takes months to recover from. We understand the hesitation and worry on a personal level, as we’re entrepreneurs ourselves.
On the upside, invoice financing is not risky if you have creditworthy clients who pay their invoices on time and you proactively manage other associated invoice finance risks. Another plus is that the risks associated with invoice financing are smaller than those of other traditional financing options, as we’ll explain.
What Is Invoice Financing?
Invoice financing is often just another name for invoice factoring, which is a form of receivable financing where a business owner sells invoices to a factoring company to get funding quickly. You receive cash for the invoice amount, usually less any fees, ahead of the payment terms. Your customer, who is responsible for paying the invoice, instead pays the invoice amount to the receivables financing company according to the original payment terms. Invoice financing services are a flexible way to get funding for your business any time you need it to cover operating expenses like payroll and inventory purchases, or taking on a growth project. Many businesses like this form of invoice finance as it helps them solve cash flow challenges and bridge cash flow gaps. Here are a few invoice factoring examples if you’d like to see how it can work.
It can also refer to when an invoice financing company gives you cash for your unpaid invoices, but you (rather than your customer) repays the accounts receivable factoring company yourself. For the purposes of this piece, we’ll use the context of invoice financing being another term for invoice factoring.
5 Invoice Financing Risks and How to Manage Them
Invoice financing can be a useful way for businesses to improve their business cash flow challenges and manage their access to capital, but like any financing method, it’s not without risks. Here are some of the risks of invoice financing and how they can be managed:
1. Funding invoices for unreliable clients
One risk associated with invoice financing is funding invoices for unreliable clients. Because invoice financing relies on your customer’s credit rating and creditworthiness, if they don’t make their payments, you may not qualify for accounts receivable funding. You could also be on the hook for the unpaid invoice, if you client defaults on payment. This is what’s known as recourse factoring, or factoring with recourse. To mitigate this risk, carefully choose which clients to fund invoices from. Additionally, working with a partner who will work with you when a customer doesn’t pay (like FundThrough) can also help lower the impact of this risk. You might also consider working with a factoring company that offers a type of invoice factoring known as non-recourse factoring. With non-recourse factoring, the factor assume the liability of any funded outstanding invoice (although this type of factoring is more expensive.)
2. Concerns about customer perception and relationship damage
Many business owners believe this form of funding has a negative perception. You might think that your customer will think your business is in financial trouble or has cash flow issues if you factor invoices, but that’s just not true — many businesses factor invoices to speed up access to cash and more reliably serve customers. Factoring also has a bit of a bad rap due to some bad actors hounding customers for payment. At FundThough, we avoid damaging relationships by treating your customer like our own. Plus, we always contact you first before contacting your customer about payment.
3. Not reading the fine print of the contract
Additional invoice factoring risks include the a perception that many traditional factoring companies charge hidden fees, don’t fund the full invoice amount, or make you sign contracts that force you to fund all invoices for a customer or fund a minimum dollar amount every month. Hidden costs can quickly add up. That’s not something you need to worry about with FundThrough. We don’t charge any hidden fees and we’re transparent about our prices, so you always know complete funding costs before you factor an invoice.
4. Not properly recording invoice financing transactions in accounting
Many business owners think that recording invoice financing transactions in their accounting software is confusing or difficult. Don’t stress. Our step by step guide will walk you through the process.
5. Choosing a partner with a slow, manual process
The policies and manual processes of traditional invoice financing companies result in a slow, expensive, rigid solution. Tech-powered invoice financing providers solve the problems of traditional invoice funding while making the benefits even better. (FundThrough uses an online application process, artificial intelligence, and integrations with popular accounting software for a streamlined experience.)
Is invoice finance a good idea?
Invoice finance is a good idea for many businesses. If you’re looking to speed up payments, eliminate late payments, improve cash flow issues, and lessen the admin associated with chasing down invoice payments, invoice financing could be a fit for your business. It’s also a good option for businesses with little or no credit history, bad credit, or a low credit score who don’t qualify for traditional bank loans. Even if you qualify, you may want to avoid bank financing hassles. With invoice finance solutions, the approval process is faster and easier. Because it relies on the credit risk your customer poses rather than your business credit history, your risk profile is lowered. Financing your outstanding receivables also gives you steady cash flow to take on business growth.
Why is invoice factoring risky?
Invoice factoring can be risky, but the major potential risk has to do with your unpaid customer invoices. If your customer doesn’t pay their invoice on time, you could be on the hook for any outstanding invoices. There’s also the risk that your customer relationship is damaged by an invoice finance company, which is why it’s important to work with a invoice finance provider that prioritizes your relationship with customers.
What are the problems with invoice factoring?
There are a couple of perceived problems with invoice factoring, including not reading the fine print of your factoring agreement. This misstep could leave you paying costly service fees, invoice factoring fees, application charges, or other additional charges. Additionally, working with invoice factoring companies that use manual processes could lead to a delay in funding.
What is the disadvantage of invoice financing?
The main perceived disadvantages of factoring as a type of financing include the need for customer contact, that factoring transactions are difficult to account for in bookkeeping, the lack of control over the collections process, and the cost of invoice financing.