For invoice factoring, the similarities between a traditional loan process ends in the sense that both has an application and approval process. Factoring is a three party system rather than a two party system like loans are, consisting of three factors: company, debtor (customer), and the factor. What makes factoring so different from traditional loans is that companies are looking into your monthly invoices and the clients you extend a limited line of credit to, rather than looking into your credit history.
To apply, most factoring service providers have online applications where you can input detailed descriptions in regard to your invoices. This is where you would prove your invoice credibility to the factoring providers by providing payment history, invoice receipts and any other documents that indicated you are a low risk invoice sale. You can either set up an account, which you can continuously add invoices down the future or sell invoices on an individual basis. Opening an account would be a better choice though for economical reasons, it helps prevent paying multiple charges for the same action and most factoring companies may have startup fees to run a credit check.
After being approved to sell your invoices, you will sign a written contract approving the factor providers the rights to collect on your bills in exchange for an agreed “cash advance.” The advanced amount ranges from 50 to 95 percent, rest of the amount given after the business owners have paid the bill in full, minus the factor’s cut from the advance. An example of this would be a $10,000 factored invoice for a $9,000 in advance at a 5% rate. The factoring company would immediately provide you $9000 and would pay you the rest of the $500 (the left over amount from the 5% the factors took for their service) later, after the debt has been paid in full.
Potential Downside to Factoring:
The allure of invoice factoring is clear–instant cash. All companies need money set aside in order to operate effectively. There can never be too much cash. But there are factors to be aware of before considering business cash advance:
· Customer Notification of Invoice Transfer: 78 percent of invoice factoring requires a notification of the invoice transfer to the customers according to the CFA. Some businesses may be required to notify customers where their invoices are going, which may cause customers to think that your business is not financially stable and could look elsewhere for businesses that are better off.
· Outsourcing Collections: By outsourcing your invoice to collections, your company no longer has control over the customer service aspect. Your clients can view your company negatively if the factoring company you chose to sell your invoices to is too aggressive with them, or are unhelpful with questions in regards to billing.
Many problems associated with factoring service though can be prevented. Before anything, put yourself in you client’s shoe and try to view it from their perspective when they interact with your factoring service provider. Visit potential factoring companies and listen in on their client phone calls. Make sure the company you chose treats your clients the same way once transactions are finalized by asking for referrals, even though you may have been pleased with the initial service.
Getting the Most from the Factoring Agreement
You can transfer invoices in variety of different ways, even though factoring is contractual. Invoices can be factored one at a time or grouped together either in large or small amount. No matter how you transfer invoices, you will be charged according to your credit history of your client, the total invoice amount and payment schedule. Because each merchant cash advance has their own method to determine their rate, approval process and advanced payment amount, here are a few things they would consider before billing:
- Billing: The more work the factors do, the more expensive it is going to be for you. Bills already delivered will have more favorable rates compared to ongoing billing, which requires an open bill and more interactions for the factor.
- Invoice Amount/ Quantity of Invoices: Invoices that are higher in dollar will lead to a better deal and a higher cash advance for your company, even though you may not be able to negotiate the factor’s cut. Depending on a few high priced invoices versus many small bills will require the factor to do less work, resulting in a better deal for you.
- Recourse Factoring: For invoice factoring service provider, they cannot lose. Either way, they are getting paid no matter whom that it may be from, your customers or yourself. This is a great deal for them because your business will return the cash advance even if your client does not pay back the debt. You take on the responsibility of repaying the cash advance and the incurring penalty fees even if your customers defaults on their debts.
Lydia Kim writes extensively for Resource Nation and VoIP service, an online resource that provides expert advice on purchasing and outsourcing decisions for small business owners and entrepreneurs with local and national pre-screened vendors. Resource Nation empowers businesses to make smart choices.