Invoice factoring is the practice of selling accounts receivables to a third-party collector. Known as the factor, this third-party collects the money your clients owe you. When you sell your accounts receivables, the factor advances you a percentage of the money your clients owe, typically between 80 and 95%. The amount of money you receive upfront depends on the industry and quality of your accounts.
Costs of Factoring for Small Business
Some companies charge a flat fee, often referred to as a discount rate, for factoring. However, it’s more common for companies to charge a percentage of your invoice. Imagine that a company charges 3% every 30 days. If you sell a $1,000 invoice and it takes 95 days to collect, you’d pay $90 ($30 for every 30 days) in fees. It’s also common for companies to use a combination of methods. For example, you may pay a 1% flat fee, then have to pay a 2% fee every 30 days.
When is Small Business Factoring Useful?
Factoring is especially helpful if your small business needs immediate cash flow and would suffer if you had to wait for your clients to pay their invoices. Factoring is based on your clients’ credit ratings, not yours. This is a significant benefit if you own a new business and are in the process of building your credit rating.
If you’re trying to determine whether you should use factoring instead of a loan, there are some important factors to consider. Benefits of factoring include:
- Approval takes days as opposed to weeks or months.
- There’s no funding cap.
- You aren’t taking on debt, as you’re selling accounts receivable.
If you need quick cash and don’t want to add liability to your balance sheet, factoring is a good way to go. Another benefit of factoring is the ability to get quick cash even if you’re a startup company. However, there are also some downsides to factoring, including:
- Factoring is generally more expensive than other forms of credit.
- It’s not a great long-term cash flow solution.
- It’s often more labor intensive than getting a loan.
- You lose a bit of control over client communications.
If you decide to use invoice factoring to acquire some quick cash, it’s important to keep track of the fees. By using an online accounting solution, you can record factoring fees and keep track of your finances. Improve your cash flow with invoices, payments, and expense tracking. See how much cash you have on hand with QuickBooks.