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A complete guide to invoice factoring

By 8fig team | January 30, 2023
A complete guide to invoice factoring

As the owner of an eCommerce business, you probably know how difficult it can be to maintain consistent cash flow. Many online sellers turn to alternative forms of financing in order to keep their businesses going. One of these is invoice factoring.

Boost your cash flow with 8fig.

Most eCommerce business funding options require an extensive application process and you’re not guaranteed the amount you need at the time you need it. This is a struggle for a lot of small business owners, as eCommerce companies usually don’t have the extra funds to pay for expenses during the slow seasons. Plus, with all of the supply chain expenses that need to be paid, it can be hard to stay in stock to keep up with customer demand.

In order to keep your business running smoothly, you need stable cash flow. Without it, you become stagnant, or worse, start to decline. Invoice factoring is one of the funding solutions that many eCommerce businesses use to improve their cash flow. Read on to learn more about this unique type of financing.

This article covers:

  1. What is invoice factoring
  2. What is a factoring company
  3. How does invoice factoring work?
  4. What are the pros of invoice factoring?
  5. What are the cons of invoice factoring?
  6. Types of factoring services
  7. Myths about invoice factoring
  8. What do you need to qualify for invoice factoring
  9. Hidden fees in the contract
  10. Other funding options

What is Invoice Factoring?

Invoice factoring is a type of alternative funding in which a business sells their outstanding invoices to a factoring company in exchange for fast cash. In most cases, you’ll only receive part of the value of your invoice up front. This percentage varies, depending on the type of contract you work out and the company you’re working with.

When the invoice is paid, the money goes directly to the factoring company. They then give you the rest of the value of the invoice, minus a fee for their service.

Many businesses benefit from invoice factoring because it allows you to receive your revenue before the customer pays their bills or the selling platform releases the funds. It’s a great method for those who have large outstanding balances and long payment terms. If this sounds like your type of business model and industry, then it’s definitely worth speaking with a factoring company.

What Is a Factoring Company?

A factoring company is a financing partner that purchases your invoices at an agreed upon discount. They’ll determine your invoices’ worth, your company’s worth, and your business history. It also depends on the type of invoices you have.

Once the factoring company approves you for financing, they’ll lend you up to 90% of the invoice’s value up front. This is helpful in every aspect of your business, as it provides you with much needed capital to keep your business running smoothly. More cash flow means that you’ll be able to keep up on expenses such as inventory procurement, shipping, platform fees, and payroll. You can’t sell products if you don’t have enough inventory in stock, and you need consistent cash to purchase that inventory.

How Does Invoice Factoring Work?

Invoice factoring is a simple process. If you can provide the necessary information to verify invoices, you can get your much-needed cash in as little as a few days.

Let’s go over the steps involved in invoice factoring.

1. Provide a service or sell a product

Invoice factoring is relevant for businesses with invoices. This means that if you provide a service or sell a product and have outstanding invoices that haven’t been paid, invoice factoring might be right for you.

Once you provide a service or sell a product, you’ll have an invoice to sell to a factoring company. This starts off the whole process.

2. Find a factoring company and apply for financing

If you lack the funds you need for your business expenses, it’s time to consider funding options. If unpaid, outstanding invoices are a problem for your cash flow, invoice factoring might be the option to choose.

The next thing you need to do is find a factoring company. There are several, so do some research on the ones that would benefit you the most. Pay particular attention to the percentage of the invoice they are willing to transfer right away, the fees they charge, and their requirement for approval. There are those who specialize in certain industries and even budding businesses.

3. Submit your invoice to the factoring company

Once you’ve chosen an invoice factorer that suits your needs, it’s time to sell them your invoices. The invoice factoring company will buy the invoice according to the agreement you make when you get approval for funding.

4. The factoring company sends you an advance

Once the invoices have been reviewed and the agreement has been made, you’ll receive your cash advance. This is usually between 80-90% of the invoice total, but varies based on your business and the invoice factoring company you choose. One of the benefits of invoice factoring is that factoring companies transfer you the advance very quickly, often in just a few days. Then, you have working capital to use for your business expenses.

5. The customer pays the invoice

Since the factoring company now owns your invoice, they’ll collect the payment from your clients once it’s due. After the long repayment term is up, the client will pay the factoring company. However, if the customer fails to make their payment, it’s still your responsibility. Be sure to check the factoring company’s policies for this situation.

6. The factoring company transfers you the balance

After the customer or client pays the invoice, the factoring company will transfer you the balance. You’ll get the full value of the invoice, minus a fee that the factoring company collects.

What Are The Pros of Invoice Factoring?

There are several pros to invoice factoring. Waiting around for your cash when you have bills due can be very frustrating, and can even harm your business. That’s why getting your cash quickly is a huge point in the win column for this alternative funding method. Plus, there’s no limit to how many times you can use a factoring company.

Another benefit is that it’s often easier to get approved for invoice factoring compared to business loans or even lines of credit. They typically don’t even require any collateral in exchange.

Here are some of the top reasons that many small businesses choose invoice factoring as their funding method:

  • Quick cash
  • Easy and fast approval process
  • No limit on usage
  • No collateral needed
  • Doesn’t hurt your credit score

What Are The Cons of Invoice Factoring?

As with any type of financing, there are some downsides to using invoice factoring as a funding solution. There are fees associated with working with a factoring company that vary in cost, depending on the company you’re working with. These tend to be quite high compared to other funding methods.

Remember, with invoice factoring, you’re sacrificing a portion of your revenue in exchange for a quick turnaround. If you can manage consistent cash flow on your own, then losing that percentage of revenue can hurt you in the long run. Unless you are comfortable with the losses, you may not want to hand over that money to a third party.

In addition, the factoring company takes on a large part of your customer relationships when they purchase your invoice. You may not want to risk the relationship between you and your client in the case that the factorer treats them poorly. This can damage your reputation and even result in lost customers and lost future sales.

You also have to worry about liabilities. Sometimes, those invoices don’t get paid. That means you may end up owing a portion or all of the advance they gave you. You’re relying solely on your customers, so check out their payment history before handing them over to a factorer.

Here are the downsides to invoice factoring:

  • Possible high fees
  • Liabilities
  • Lack of control

Types of Factoring Services

There are many factoring companies out there, and each provides different kinds of services. It’s important to take the time to research your options to find one that accommodates your business goals and unique needs.

Factoring companies can be individually owned or bank owned, so there’s no shortage of places to look. This method is quickly gaining popularity among growing businesses and those who are just starting out. Even if you’re a budding company, you don’t have to wait to start growing. It takes time to collect those invoices, so take advantage of what a factoring company can do for you, as long as it fits your business goals.

These are the types of services that a factoring company can provide you.

1. Recourse

This option is the riskiest of the bunch, as it requires you to pay back any unfulfilled invoices. A recourse factoring agreement can pose a tremendous problem, especially if you’ve already spent the money they advanced you.

If you aren’t able to pay back the full amount, it also hurts your chances of working with that factoring company again. However, this type also offers lower fees, which means a greater profit margin for you. The more money you have, the faster your business can grow. So, if you decide to use this service, then it’s best to have a reserve fund in place, just in case.

2. Non-recourse

A non-recourse factoring agreement is the opposite of recourse. You will have to pay higher fees than you would with a recourse agreement because they will cover any unpaid invoices. This is riskier for the factoring company, so they cover their risk by charging higher fees.

You may find that this is worth the extra cost, since you won’t need to worry about paying back the invoice if the customer fails to do so. As always, it depends on your individual goals and needs, but many business owners feel that this is the safer option in the long run. You’ll have to negotiate the fees associated with a non-recourse agreement, as every contract is different.

3. Spot factoring

This service is meant for those businesses who need one large, outstanding invoice paid right now. The factoring company will give you the funds for that one large invoice very quickly. The details for spot factoring vary depending on the factoring company you work with.

More often than not, you’ll need to sign a recourse factoring agreement for spot factoring, so you’ll have to pay the advance back if the client fails to pay their invoice. However, it’s a great option for those who are in a bind. Maybe your inventory needs a boost now because demand suddenly sky-rocketed, or your interest increased on that business loan, and you need to catch up. With spot factoring, you’ll get capital fast to pay those unexpected costs.

4. Whole ledger factoring

Whole ledger factoring requires you to factor all your invoices together. It gives you some flexibility with fees, as they may be lower since you are offering all of your accounts receivable to this factoring company. This will increase your cash flow quickly. You can use the extra funds as needed, such as to procure more inventory or to boost your advertising budget. This just means more invoices for factoring in the future.

Myths About Invoice Factoring

There is a lot of information out there about invoice factoring. Before making a decision based on what you hear, take the time to research factoring companies and reach out to them directly. Make an educated decision when deciding to fund your business with invoice factoring, and select a factoring company carefully.

Here are some common myths about invoice factoring.

1. It’s only for struggling businesses

Invoice factoring can be a big help for a struggling business. It helps them catch up on expenses by providing much-needed cash flow. But it’s certainly not just for those who are falling behind.

This method of funding is a great solution for all stages of business growth. Many large companies use invoice factoring to reduce debt. For example, if they have a business loan, they can use that quick cash to put more down on the payment. This leads to lower interest in the future. The extra working capital can also be a big help for businesses trying to scale. You can use the funds to launch a new product or stock up on more inventory. There are many ways to use invoice factoring to your advantage.

2.  It’s too expensive

While it’s true that invoice factoring can be more expensive than most alternative funding solutions, it doesn’t mean that it’s the wrong choice. Businesses that can raise prices without impacting demand too heavily benefit from this option. They can simply raise their prices over time to compensate for the fees that factoring companies charge them. Plus, you can dictate just how much you’re willing to pay your factoring company by choosing between a recourse or non-recourse factoring agreement. In the end, it’s a balancing act, but it’s certainly doable for small businesses as well as larger companies.

3. You can’t do it with bad credit

Factoring companies don’t prioritize your credit score the way many banks do when you apply for bank loans and lines of credit. After all, you’re not the one paying the invoices, the customers are. That’s why they review the history of your customers before coming to you with a contract. The customers’ creditworthiness is what matters most in this situation, so if you don’t think you have the most financially stable customers, then you may have a reason to be concerned. Otherwise, you’ll have no problem finding a factoring company who will work with you.

4. All invoice factoring companies are the same

No two factoring companies are exactly the same. There are some that will try to take advantage of you by charging outrageous, and sometimes hidden, fees. Others will provide you with a fair deal, no matter what state your business is in. That’s all the more reason to do your research and speak with them before signing any sort of agreement. It’s also a good idea to reach out to your fellow business owners to ask which factoring companies they work with. Look up reviews and compare their numbers. You’ll thank yourself later for taking the time to protect your business.

What Do You Need to Qualify for Invoice Factoring?

As easy-going as they are known to be, you’ll need a few things before you can qualify to work with a factoring company. You’ll begin with the application. This is where the nitty gritty details come in, like monthly invoicing volume. Second, they’ll want an accounts receivable aging report. This is the report that lists all the outstanding balances, unpaid invoices, and credit memos. Third, you’ll need a copy of your articles of incorporation. Essentially, this is proof that your business is a real business. Fourth, you’ll need the invoices to factor. Finally, you’ll need credit-worthy clients, which is what they really care about. Once you have these things in hand, you will move swiftly through the process.

  • Application
  • Accounts receivable aging report
  • Articles of incorporation
  • Invoices
  • Credit-worthy clients

Hidden Fees in the Contract

We can’t say this enough—the best factoring companies will be transparent about their contract. It’s always important that you read over the contract thoroughly and determine if it’s beneficial to you before signing. If the wording isn’t clear or you’re unsure about the fees that you have to pay, then you may want to continue your search.

The types of hidden fees to watch out for are:

  • Float days and fees
  • Due diligence fees
  • Maintenance fees
  • Monthly minimum fees
  • Cancellation or termination fees

Other Funding Options

Before selecting a funding option, it’s a good idea to know what types of funding are out there. There may be reasons that invoice factoring won’t work for you and your industry, and that’s perfectly fine. There are many more forms of alternative funding for you to consider.

These are some other popular funding solutions:

Merchant cash advance (MCA)

If you have a hard time getting approved at banks, then a merchant cash advance is a good choice. It’s often easier to get approved for, and your credit score isn’t always a factor in their decision. If approved, they’ll provide you with a lump-sum of capital in exchange for a percentage of your future credit card sales.

The great part about this option is that you have complete control of what you spend the money on. Plus, instead of fixed monthly payments, you just pay back a percentage of sales. This is great for businesses with seasonal sales, or those with unpredictable fluctuations in revenue.

Business line of credit

If you’re looking for a revolving credit, so you always have money to pay expenses, then a business line of credit might be beneficial. The money becomes available to you again as you pay off the loan, and you’re only charged interest on the portion of the loan you’re using. They typically have lower interest rates, and it’s easier to access than most funding. The down side can be the amount you are approved for. Most of the time, these loan limits are on the lower side.

Business credit card

Business credit cards are great short-term solutions for things like building up your inventory or paying day-to-day costs. They’re great for managing your business in between invoice payments, and you should be able to pay them off quickly. So long as you have a decent credit score, your chances for approval are high. You don’t even need a business plan, unlike most bank loans. The processing time is quick, so you can start using your credit card right away. Just watch out for interest rates. They vary depending on the lender and your personal finance history.

8fig

This is a great option for eCommerce sellers who need help with their cash flow. 8fig provides businesses with the ability to plan, manage, and fund their business. Our funding method is built with eCommerce cash flow in mind, and our platform optimizes your cash flow for you while funding your growth. 8fig funding is continuous, which means that instead of one lump-sum, you get cash infusions into your business over and over when you need it most. It’s also flexible, which means you can change any aspect of your plan in real time, as you adapt to the ever-changing world of eCommerce sales.

Sign up for an 8fig Growth Plan today and find out how you can grow your business.


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