If you are a small business owner facing a cash flow issue in the near future, you may be wondering where you can find the money you need to keep the lights on.
One way of getting an infusion of cash into your business quickly is with invoice factoring. Invoice factoring (sometimes referred to as just “factoring” or a “factoring loan”) allows you to turn your unpaid customer invoices into cash.
How Invoice Factoring Works
Let’s say that you need to pay rent next week, but you don’t have enough in the bank to do so. However, you have made sales — you hold $2500 in unpaid invoices for goods or services that you have rendered.
To get fast cash, you can sell your invoices at to a factoring company — say, $2500 minus a 2% fee for a net of $2450. They will advance you most of the invoice (e.g., 90% or $2205) in just a few business days.
At this point, the factoring company is responsible for collecting the invoices when they come due. Once done, they will provide you with the remaining balance owed ($2450 due to you – $2205 already advanced = $245 remaining).
Loans vs. Invoice Factoring
As we mentioned, invoice factoring is sometimes referred to as a factoring loan. Strictly speaking, however, invoice factoring is not a loan.
Traditional loans typically require good credit scores and collateral to back the loan. Depending on the bank or the loan type, the application process may take some time; if you are approved, there may be an additional waiting period before the bank disburses your funds.
If you are facing an immediate cash flow problem, these waiting periods might mean that small business loans from the bank might not be a workable option for you.
The Costs of Invoice Factoring
However, the price of fast cash is high. In the example we covered in the section above, paying the factoring company $2500 for $2450 in cash is equivalent to a short-term loan with an interest rate of almost 25%. This amount can go up quickly, especially as your factoring fee increases.
Factoring fees can be as low as 1% or as high as 5% (or more). The specific rate you get depends on factors like:
- What the bank offers
- The invoice amount you want to factor
- Your sales volume
- How creditworthy your customers are
Furthermore, there may be additional hidden fees that drive up the cost of invoice factoring. For example, the factoring company might ask for the likes of application fees and processing fees.
And, if your customers do not pay their invoices, you might be on the hook for this as well. Contracts, where you are held responsible for unpaid invoices, are called recourse contracts. In this case, you will be asked to buy back the unpaid invoice or replace it with another invoice of equal or greater value.
When is Invoice Factoring Not For You?
Because you are selling your invoices to the factoring company, you are entrusting a third-party company to work with your customers. Depending on the factoring company, they may or may not behave ethically when contacting your customers to collect on the invoices they now own.
If the factoring company behaves poorly, this can reflect badly on your business.
Invoice factoring is also expensive. We mentioned that the fees assessed can mean that you are paying what’s equivalent to a sky-high interest rate. If you have few or no other options, invoice factoring can keep you solvent.
However, the price for this might put you in a perpetual cycle where you are always needing fast cash to cover budgetary shortfalls that are partially caused by the expensive financing you use.
Alternatives to Invoice Factoring
Invoice factoring isn’t the only option available to you when it comes to obtaining fast cash. Other options you might consider include:
- Invoice financing: you receive a cash advance from the lender, using your invoices as collateral. You do not sell your invoices unless you are, at a later date, unable to repay your cash advance
- Merchant cash advance: you obtain a cash advance from the lender in exchange for an agreed-upon percentage of future credit or debit card sales.
Depending on the terms and rates your lender presents you with, invoice financing and merchant cash advances might be cheaper than invoice factoring (though, again, they could also be more expensive). More, invoice financing and merchant cash advances allow you to conduct contact with your clients as usual.
Regardless, small businesses seeking fast cash to cover cash flow issues would do well to research all options available to them.
The Invoice Factoring Application Process
If you have decided to proceed with invoice factoring, here’s what you can expect from the application process.
- You will fill out an application with the lender. In addition to your contact information, the lender wants to know how much money you are requesting.
- Next, the lender will ask for your financial details. The company may ask for access to your accounting software or similar to check your business credit, transaction history, and invoices.
- At this point, the factoring company is ready to offer you a decision, along with the terms of the agreement (including factor rate) if you’ve been approved for financing.
In most cases, the application process takes less than a few business days with disbursement (if you have been approved) occurring shortly afterward. That said, approvals can take as little as a few hours.
Choosing a Factoring Company
|Factoring Lines||$5 million||$100,000|
|Rate||from 0.25%||2% to 10%|
|Approval Speed||24 hours or longer||As fast as a few hours (as claimed by Fundbox)|
|Application Requirements||530+ FICO score|
3+ months in business
$100,000+ in annual revenue
|Business checking account|
2 months of accounting software activity
OR 3 months of business bank statements
|Website||Visit BlueVine||Visit Fundbox|
BlueVine is a provider of multiple fast funding options for businesses. BlueVine offers factoring lines up to $5 million, and you can be approved in as fast as 24 hours.
During the application process, you may manually upload your invoices, or provide the business-related information BlueVine needs by syncing your accounting software. If approved, BlueVine will disburse between 85-95% of the money upfront, with the rest coming once the invoices have been paid.
BlueVine’s minimum requirements for invoice factoring include:
- A credit score of 530+
- At least three months in business
- $100,000+ in annual revenue
Your invoices must also be B2B (business-to-business); BlueVine does not work with B2C (business-to-customer) invoices.
Should your account remain in good standing, BlueVine does not interact with your customers at all. Another upside is that they offer factoring lines up to $5 million.
Fundbox is a San Francisco-based FinTech company offering fast cash products to small businesses.
To apply for invoice factoring, you need to register an account and provide access to your accounting software. Fundbox promises a response in hours, and if you’re approved, you could receive the requested funds on the next business day.
Fundbox’s application requirements are:
- Ownership of a business checking account
- Two months of activity in supported accounting software or three months of transactions in a business bank account
- At least $50,000 in annual revenue
Like BlueVine, Fundbox only works with B2B invoices and does not engage with your customers if your account is in good standing. However, Fundbox only offers factoring lines of up to $100,000, with a broad 60%-95% invoice coverage.
Small businesses that are facing cash flow issues can use invoice factoring to turn their unpaid B2B invoices into cash they can use for things like payroll and rent. Though this type of financial product can be expensive, it is something owners and managers should consider if necessary.