Maintaining a steady cash flow margin for a small business can be challenging. Even if you eventually get a significant new contract, you’ll still need to find money to pay your employees’ salaries and purchase company supplies. Funding may be difficult, particularly if your new customers fail to pay by the required invoice payment terms and income is delayed.
Many business owners turn to their bankers for assistance when in a crunch. However, obtaining a bank loan to bridge the gap between services rendered and bills received is difficult. To be realistic, it’s not something you will usually do. On the other hand, those who do provide accounts receivable loans are generally very costly. Another option is to use a credit card. However, if you don’t have the funds to pay off the amount, the fees and interest make it a wrong choice. Because of this, it makes accounts receivable factoring a viable solution.
What Is Accounts Receivable Factoring?
Accounts receivable financing, often known as invoice factoring, is not a loan and therefore does not affect your credit. On the other hand, invoice factoring is a financial solution that enables company owners to leverage upcoming revenue to get the money they need now. It occurs when a company sells preceding invoices that are subsequently payable to a third-party firm. The third-party company is a “factor,” and it pays companies immediate cash or bills with future due dates corresponding to a fee.
Factoring enables companies to obtain an advance on the money due to them by their clients. It provides companies to fulfill their immediate financial commitments, providing a flexible, low-risk option for cash-flow problems. Both sides must sign a factoring agreement or a contract between a factoring services provider and a business to move forward in the transaction.
How Does Invoice Factoring Work?
When you choose to work with a factoring company, they will purchase your client receivables and then promptly pay you, typically on the same business day. Because a factored invoice is not considered a loan, your business incurs no additional debt. Based on a typical factoring agreement and procedure, here is a comprehensive, step-by-step overview of the invoice factoring process.
- You supply your products or services to your client as usual. You bill your client once the products and services are provided.
- Once you receive the invoice, you submit it to a third-party entity that “purchases” it. You are then immediately given an advance payment, typically 80% or more of the invoice amount. The rest, which is about 20%, is kept in reserve.
- Your client will then pay the third-party supplier using your invoice (with your name on it). The reserve amount, with fewer transaction costs, is delivered to your business after payment is made.
The key here is that you get the majority of the money due to you relatively fast. It will ensure that you can pay the costs of operating your business while still having the cash you need to expand.
Key Advantages of Invoice Factoring
As previously said, the most significant advantage of accounts receivable factoring for a small business is that you may get money due to your company without having to wait for consumers to pay.
Invoice factoring does not have to be a one-time transaction. You can establish a relationship with your factoring provider that will last if it benefits both businesses. Avoiding cash flow problems will be simple since you will not have to wait for bills to be paid before having money in your monthly bank account. Furthermore, the invoices serve as collateral, so you won’t have to provide real estate, machinery, or other significant forms of valuables.
Not every financing option is suitable for every small company. While accounts receivable factoring may benefit specific companies, you should also consider business loans, cash advances, and lines of credit. On the other hand, an invoice factoring solution may benefit your small business if you have dependable clients with a reputation for paying invoices on time and can afford the costs associated with it.
Porter Capital assists businesses in various sectors with invoice factoring and asset-based financing. We have a reputation for serving all types of industries, some of which include: