The Pros and Cons of Invoice Factoring
There are many options for small businesses looking for financing, some of which are easier to obtain than traditional lending practices. For companies who are starting out or who cannot meet the stringent application criteria of major lenders, factoring can be an avenue for bringing in extra cash. Before choosing this option, explore the pros and cons associated with this financing.
What is it?
With this financing, a company converts outstanding customer invoices into working capital through the work of a third-party lender called a factor. The factor offers a cash advance for a portion of the open amount, usually 70% to 90%, and then works directly with the customer to collect payment. Once received, the factor issues a refund of the remaining amount, minus a fee, back to the company.
Using factoring allows a company quick access to cash without worrying how their credit will impact the lending opportunity. Many banks and traditional lenders require strong credit scores, collateral and a solid business history before approving loan applications, making it difficult for a new business to obtain cash. This process relies on the client’s credit and payment history, taking the burden of the company. Also, a traditional loan has a lump sum payment with financing terms that could potentially impact a company’s budget structure. If a company chooses to factor invoices, it can be done on an as needed basis, protecting their financial situation while still boosting their working capital. This process also solves many problems when it comes to accounts receivable and collections. The factor company take the responsibility for collecting what it owed.
Factors will typically advance only 70-90% of the receivables. With smaller sized deals, the advance is less.
Single invoice factoring is technically not a loan, and it is therefore not bound by the same government regulations that traditional bank loans are bound by. Instead of interest rates, the factor charges fees of anywhere from 5% to 15% of the invoice. Depending on the level of risk, some companies charge 30% or more in fees. That said, it is important to shop around and find the best rates before you decide to factor your invoices.
Pros and Cons of Single Invoice Factoring
Because factoring companies assume a lot of financial risk, their fees can be quite pricey. In fact, it is one of the more expensive business financing options.
On the other hand, one of the benefits of single invoice factoring is that the lender is less concerned about credit score and more focused on cash flow; while banks turn you down based on overall creditworthiness, a factor will focus on the quality of an invoice itself.
In the end, a traditional loan from a bank is the better route, but that doesn’t always work. If your business really needs the money and needs it fast, single invoice factoring helps you get financing that other lenders are not willing to grant. Through Lendio’s free loan match tool, you can easily find out which loans are the best fit, and we match you with the best rates.