Knowing invoice factoring pros and cons is a crucial first step that will help ensure you have a good experience and the right expectations going into your new factoring relationship. We’ll go over some of the benefits and potential drawbacks below.
Introduction to Invoice Factoring
Before we get into invoice factoring pros and cons, let’s quickly review what it is and how it works.
What is Invoice Factoring?
Invoice factoring, sometimes referred to as accounts receivable factoring, unlocks the working capital trapped in your unpaid B2B invoices.
How Invoice Factoring Works
Once you’re set up with an invoice factoring company, you send them any invoices you’d like to accelerate payment on. The factoring company purchases the invoice from you and immediately advances up to 95 percent of the invoice’s value. The remaining sum, minus a small factoring fee, is sent when your client pays the invoice.
Invoice Factoring vs. Invoice Financing
The phrases “invoice factoring” and “invoice financing” are sometimes used interchangeably, though they are distinct concepts.
- Invoice Factoring: Your company obtains working capital by selling its receivables.
- Invoice Financing: Your company obtains a loan that leverages your receivables as collateral.
Recourse vs. Non-Recourse Factoring
There are two main forms of factoring: recourse and non-recourse.
- Recourse Factoring: Your company is responsible for the balance if a client doesn’t pay their invoice. Most factoring companies simply have you submit another invoice of equal value. This is the most common option and has the lowest cost.
- Non-Recourse Factoring: The factoring company absorbs the cost if your client doesn’t pay their invoice.
Pros of Invoice Factoring
Now that we’ve gone over the basics, let’s explore some of the benefits of invoice factoring.
Most Businesses Are Approved
It’s easy to get approved for invoice factoring. You can qualify even if you don’t have strong credit or have been denied bank loans. Your clients are responsible for paying their invoices, so their creditworthiness is more of a concern than yours.
You Can Get Cash Instantly
Whereas business loans and other financing options may take weeks or months to pay out, you can immediately receive your factoring cash. Most factoring companies pay via ACH, so cash hits your account within two business days of your invoice submission. Some offer payments as soon as the same business day.
Your Business Doesn’t Accrue Debt
Factoring isn’t a loan, so there’s nothing for your business to pay back. This can help your business keep its debt ratio low and allow you to build stronger credit.
You Don’t Need to Chase Invoices
Your factoring company collects payment for you. Some will prepare invoices for you, too. Outsourcing these tasks can save time and money.
Your Bad Debt is Likely to Decrease
Your factoring company will perform client credit checks for you. You’ll learn how much credit you can extend to each one without exposing your business to unnecessary risk. If you follow the guidelines you’re given, your business is unlikely to be saddled with unpaid client debts.
You Retain More Control
Factoring doesn’t require you to give up any control of your company as equity funding solutions do. You’re also in control of which invoices you factor. You can factor one invoice or all of them. You can sign up for factoring and then not use it for years or start using it immediately. This also means that you have more control over the related costs.
Cons of Invoice Factoring
Despite these benefits, some aspects of invoice factoring might make it less ideal for some businesses or under certain circumstances.
Not Everyone Will Qualify
You’ll need to have creditworthy clients to qualify. Factoring companies also usually require that you follow specific best practices for invoicing, and some only serve specific B2B industries. You’re also unlikely to qualify if your receivables are collateral on a loan or if you have liens.
Not Every Invoice Qualifies
You ultimately decide who you want to work with and how much credit you extend. That means you can ignore the guidelines your factoring company sets. However, those invoices won’t qualify for factoring.
It Can Be More Expensive
The cost of factoring varies. It’s usually between one and five percent of an invoice’s value. However, if you compare factoring to a bank loan, the loan will usually come out cheaper.
Your Clients Will Know You’re Factoring
There are specific points at which the factoring company may be in contact with your clients. For example, during the initial credit check and when confirming invoices are valid. Payments are also made directly to the factoring company. Some businesses worry that this will damage their reputation or that customers won’t want to work with a third party. In reality, most large companies are accustomed to external parties being involved in billing and view it as an ordinary business activity. Some see it as a positive thing because it means you can give them longer payment terms—much of how clients respond hinges on how you present it.
It Doesn’t Solve Deeper Cash Flow Issues
Factoring is often used during periods of high growth or to ramp up for a busy period. It can help bridge gaps caused by slow-paying customers or the occasional emergency, too. This is important because eight in ten small business closures are tied to cash flow issues, Forbes reports. However, if your business lacks working capital because it’s not profitable or has other issues, it won’t solve those problems.
Learn More and Get a Free Factoring Quote
Even though factoring isn’t suitable for every situation, it can be an absolute lifeline in others and may make it easier for businesses to scale. Check out our Factoring Guide to learn more about how it works. Or, to be matched with a factoring company that specializes in your industry and offers competitive rates, request a free factoring rate quote.