For too many small business owners today, the need for an infusion of cash is a pressing concern. Most of these are actually successful businesses – they have clients on the books, and if you look at their accounts receivable, they’re certainly profitable. However, they still struggle to meet their financial obligations (that’s where invoice factoring comes in). They might:
- Be unable to make payroll
- Be unable to purchase supplies to complete other jobs
- Be forced to wait before taking on new clients
- Be unable to take advantage of unexpected growth opportunities
Obviously, this is not a beneficial position in which to find yourself. However, there is a solution for business owners caught in this seemingly endless cycle. Invoice factoring delivers the ability to leverage existing capital that’s locked up in unpaid customer invoices and put it to work on your behalf right now.
What Should You Know about Invoice Factoring?
When it comes to factoring invoicing, there are several crucial things that you should know. Let’s start with a basic overview of the process itself, and then we’ll get into some of the more important details about invoice factoring in Canada.
Really, the process is relatively straightforward. Let’s say that you have a net 60 day invoice for a customer. You’ve already delivered the goods or services, and you’re just waiting for that client to pay you so you can move on to the next job. Rather than waiting for two full months and experiencing all the problems we noted above, you can sell the invoice for cash right now.
You’ll sell the invoice to a factoring company, thus the term, invoice factoring. The company will advance you a portion of the invoice total, keeping the remainder in reserve. Once your client pays, the company assesses a factoring fee on the reserve amount, and then pays you the remainder.
Sounds simple, doesn’t it? It is, but there are a few other things you’ll need to know about invoice factoring before deciding that this is the ideal option for your particular needs.
Not a Loan
One of the most common misunderstandings revolving around invoice factoring is exactly what it is. This is not a loan. The factoring company is not a bank or a lender. They’re simply buying an asset that you’re offering for sale. It doesn’t differ at all from selling any other asset your business owns.
Technically, the money the invoice represents is yours already. You’re just getting access to it sooner than you would had you waited for your customer to pay you. There are a couple of immediate benefits to this compared to getting a bank loan.
One of those is that any business can qualify for invoice factoring. Because you’re selling an asset, rather than taking on more debt, your credit history is not a concern. However, the credit history of your client is important. If they have a history of slow payments or nonpayment, this might not be the right invoice to factor.
Another benefit here is speed. With a conventional bank loan, you can count on waiting at least a month or even two months to get access to the capital you need. With invoice factoring, you generally have your initial advance within 24 to 48 hours. That means you have the ability to almost immediately meet your cash flow needs.
There’s one more important difference here. You’re not taking on more debt. That means there’s no new liability added to your books, but you’re still able to obtain the capital you need to grow your business.
Additional Information about Invoice Factoring
Now that you have a better understanding of how invoice factoring works in the first place, it’s time to dig into some of the details and address specific terms that you’ll encounter.
Advance: One item that should be of particular interest to you is the advance offered by the factoring company. This is the amount of money that you’ll receive up front, and what you’ll have to work with between the time you sell the invoice and when your customer pays. That might be anywhere from a month to three months, so it definitely pays to make sure you know exactly how much you can expect to see from a factoring company.
Most factors advance between 70% and 90% of the invoice total. There are some that advance more than this. However, don’t let that lure you into a potentially bad deal. Understand that a higher initial advance amount can mean that you’ll pay more in factoring fees in the end, and there may also be additional fees and charges that you’ll have to pay. Ultimately, you might end up with about the same amount of cash through attrition.
Factoring Fee: Any time you consider invoice factoring, you’ll be charged a fee based on the total value of the invoice. This is the factoring fee, and it will be assessed once your client has paid, and will be deducted from the remainder (called the reserve). Like the advance amount, the factoring fee can vary from one company to another.
You’ll find that most companies charge between 1% and 5% of the invoice total as a factoring fee. Depending on the amount of the invoice you’re factoring, that can be a significant amount of money. It also does not cover any other charges or fees that the factor requires.
Additional Charges: In an ideal world, you’d only need to worry about the amount of the factoring fee. However, in that same world, your customers would pay on time, every time and you wouldn’t need to offer lengthy terms on invoice payment. Some factoring companies tuck additional fees into the fine print in your contract.
Make sure you carefully read through your contract to determine what other fees or charges are included. If you’re not completely sure that there are no other charges, ask the factoring company representative to outline exactly what you’ll have to pay and when. If they refuse to explain things, then it’s probably best to find a different factoring company with which to work.
The Factoring Company Itself: A great deal of your experience will hinge on the factoring company that you choose to work with. There are many Canadian factoring companies, and they’re not all the same. One of the first decisions you’ll need to make is whether or not you can benefit from a generalist factoring company – one that works with pretty much any client – or if you’d be better served by working with a specialist.
While some businesses can work with generalist factors, most find it better to contract with a specialist firm. You’ll find options for construction invoice factoring, freight invoice factoring, warehousing companies, manufacturing firms and many others. Why should you consider working with a specialist, rather than a generalist?
Really, it comes down to two things – knowledge of your specific industry and how it works, and unique perks that make it easier to run a successful company.
For instance, the construction industry has some very unique funding practices that mean generalist factoring companies are less likely to work with you. They perceive those practices as being too risky, even though they’re normal operating procedure within the larger industry. The trucking and logistics industry sometimes deals with smaller invoices on a faster timeframe than many other industries, and you might find that you don’t meet the minimum requirement with a generalist factoring company. A factoring firm that specialises in the trucking industry would have no problem, though.
When it comes to perks, you’ll find a number of different things in play. To go back to the trucking industry as an example, many factoring firms offer discounted fuel cards to help you save at every fill-up.
However, those perks go well beyond simply helping you save some cash at the pump. For instance, many factoring companies in the trucking specialty and the wider industry, as well, offer back-office services like billing and collections. Taking advantage of those back-office services usually costs nothing, or it might incur a small nominal fee. Again, you’ll need to verify with the factoring company you choose prior to signing a contract.
The time and effort these services can save you alone often make it well worth the decision. In some cases, it may actually allow you to avoid hiring more employees for your business, which saves you yet more money as you don’t have to pay employee payroll or benefits.
The Need to Choose Carefully
As mentioned, there are quite a few invoice factoring companies in Canada, and your experience may vary drastically depending on the one you ultimately choose. Therefore, it’s absolutely crucial that you make an informed decision about factoring. You’ll need to take several steps when choosing a company with which to partner.
Financial Details: Obviously, you’ll want to learn more about the advance amount, the factoring fee being charged and other financial details. You’ll also want to learn whether the company has a minimum amount in place. If you only have a single invoice with a lower value, or several very small invoices, this might mean you cannot work with that particular company. You’ll also want to consider the potential fees and charges, and how they affect the total amount of cash you’ll have to work with.
Contract Length: You’ll quickly find that one area where invoice factoring companies vary drastically is in the length of the contract that you must sign. Some companies do offer what’s called spot factoring, which is just the process of selling a single invoice at a time.
However, the fees here are sometimes higher, and this may not be the best option for you. Other companies require that you sign a lengthy contract in which you agree to sell all the invoices for a particular client to the company during the contracted period. While this reduces your flexibility somewhat, it’s generally more affordable.
Recourse vs Nonrecourse: Two terms that you’ll need to get very familiar with before deciding that invoice factoring is the right thing for you are recourse and nonrecourse factoring. They sound similar, but they’re very different.
Recourse factoring is the most common, and in this situation, any default on the part of your client is your responsibility. In short, if your customer decides not to pay the invoice for whatever reason, you’re responsible for paying the advance back to the factoring company. That can be a tough thing to do, particularly if you’ve already spent the money.
Nonrecourse factoring is the reverse – if your customer defaults, the factoring company takes on the responsibility. You don’t have to repay the advance, but you’ll find that the fees here are higher to make up for the increased risk.
Breaking the Contract: As mentioned, you will very likely need to sign a contract with the invoice factoring company. Depending on the company’s rules, breaking that contract can cost you a great deal. However, there are instances where you may have little choice but to do just that. Know what the fees are for breaking the contract before signing, and make sure you have a good idea of what challenges or issues your business will experience during the contract period that might necessitate breaking the agreement.
Taking the Next Step
From the information we’ve provided, it should be clear that invoice factoring can be a very beneficial option. In fact, it can mean the difference between growth and stagnation, or even business failure if your cash flow situation is particularly severe.
However, you cannot afford to go into the process of contracting with a factoring company blindly. While many companies are worth your time, others should be avoided. If you’re not entirely sure that you will be able to easily tell the difference, or find a reputable partner within a reasonable amount of time, we can help.
We invite you to take advantage of a free consultation with one of our invoice factoring specialists. Based on this consultation, we can help connect you with the ideal factoring partner and get the cash flow you need for stability, growth and profitability.