Accounts payable

What is invoice factoring and what are its benefits?

Apr 05, 2024

Invoice factoring is a way for your company to improve its cash flow by selling your outstanding invoices partially or in full to a third party while waiting on payment from customers. The third party, also known as the factoring company, will then immediately pay the invoiced amount and later receive payment from your customers.

While it can be a quick way to get cash, invoice factoring isn’t without its flaws. As with any other financing method, there are advantages and disadvantages to invoice factoring for small business cash flow.

How invoice factoring works

Unlike a typical invoicing cycle, which involves anything between 30 or 90 days of wait time before your customers settle invoices, with invoice factoring you can get paid faster. There are several steps involved in making this happen. First, you will provide your product to your customers as normal. It will be followed by invoicing your customers.

Where things start to differ is in the next step. Essentially, what is invoice factoring is you can sell an invoice, partially or in full, to a factoring company. Typically, the amount that a factoring company buys is around 80-90% of your invoice value. They’ll pay you the amount that they have purchased in full, meaning if they buy 80% of the invoice you will only have 20% left unsettled.

Your customer will then pay the factoring company 100% of the invoice value. After the payment happens, the factoring company will pay you the remaining amount unsettled—minus an agreed-upon percentage that is the factor’s fee.

When to consider invoice factoring?

If you have a B2B business with a lot of good but slow-paying customers with outstanding invoices, you may want to consider invoice factoring to quickly get cash on hand. Your customers may pay within the time stated on the invoice terms, but a 30-day waiting period could still negatively impact your cash flow.

If for some reason you need money immediately, whether that is for repaying short-term loans or taking advantage of time-sensitive business opportunities, invoice factoring is an option to consider. You can get cash within just a few business days.

At first glance, invoice factoring may seem like the ideal solution for quick cash flow in any situation. However, you should consider that factoring companies will charge a fee for paying off your invoices early.

Therefore, it is only a good idea if the benefits outweigh the costs to turn into invoice factoring. Australia also has other methods to allow you to avail of a credit line.

Advantages of invoice factoring

Improves cash flow

It can hurt your business to not have cash on hand at the very moment. Whether that’s because you have to repay a loan faster than your customers pay you or you don’t want to miss out on a seasonal business opportunity, sometimes your business needs cash right then and there.

Invoice factoring can improve your cash flow and allow you to get funds almost immediately. With cash on hand, you can make better business decisions and forecasts.

No need of personal liability

It’s no secret that bank loans can be difficult to get. This is especially true if you or your business won’t have an adequate credit score for it.

Fortunately, your credit score doesn’t matter to factoring companies. They’re more interested in the credit score and repayment rate of your customers.

If you have good customers, invoice factoring for small business owners can be more accessible than bank loans.

Easier disbursements

Bank loans are not only a hassle to apply for and obtain, but even after approval, they can also take a while to process. With how slow the entire cycle moves, it may not be the ideal solution for quickly cashing out.

Invoice factoring, on the other hand, is faster and easier to process. Even when you do it multiple times, it may be preferable to do that with a factoring company than a bank.

Quick access to cash

The most common and obvious reason you might want to turn to invoice factoring is that you need quick access to cash. Other than pushing your customers to pay as soon as possible or having to apply for bank loans, you don’t have very many alternatives.

The good thing is that you can quickly sell your invoices to a factoring company and get quick cash with invoice factoring. You can even receive payment from a factoring company within 24 hours.

Disadvantages of invoice factoring

Hidden costs and fees

Typically, a factoring company will have fees for invoice factoring.

However, the upfront fees that they state may not be all there is to it. After the factoring company pays your business, they’ll still have to ensure that your customers pay them by the end of the invoice term.

If it is difficult to get the customers to pay, the factoring company may charge extra. Not to mention that if a customer doesn’t pay, the factoring company may ask you to refund the money that they’ve sent.

Not suitable for businesses with a low customer base

As invoice factoring is risky, factoring companies prefer to spread their risk. When you don’t have a lot of customers and only rely on a main few for most of your revenue, high concentration in just a handful of customers does not bode well for factoring companies.

Therefore, invoice factoring for small business owners may not always be an option.

Smaller profit margin

There are risks involved in invoice factoring, especially if your customers are known to be delinquents.

For this reason, factoring companies will charge a fee, typically a percentage of the invoice value. This means that even when the invoice has been settled entirely, what you receive will not be the initial full value.

With riskier customers, a factoring company’s fees can be higher than even bank loans. You have to be prepared for that cut and lose some profits, which may be quite costly.

Can impact customer relations

When you sell your invoices to a factoring company, you’re essentially handing over control to them.

While some businesses may want to offload the hassle of having to chase down customers for payments to a factoring company, doing this will mean that you won’t have control over what kind of relationship is being built with your customers.

Factoring companies might employ colder ways to ensure that your customers pay them back, meaning that you can’t build good relationships and could end up losing them in the long run.

How to choose the right invoice factoring company?

Services they offer

You want to be sure that the factoring company that you work with has good customer service. Not just toward you, but also toward your customers, as they will be communicating directly with them.

If the factoring company can guarantee that they’ll maintain good relationships with your customers on behalf of your business, then that’s an extremely valuable plus point.

Industries they serve

As with every other business partner or vendor you work with, it’s always good to do business with those that have industry experience and expertise. Negotiating invoice factoring terms and fees will be easier when you and the factoring company you work with are on the same page.

More than that, factoring companies familiar with your industry will also be able to be attuned to your business needs.

Fees, rates, and structures

While all factoring companies function similarly, you’ll find that there may be differences in fees, rates, and structures. Be sure to ask upfront about any hidden costs or terms.

You want to choose a factoring company with low rates but have no other hidden fees that might crop up in the future. It’s best that you know what will happen from start to finish.

Factoring agreement

Sometimes a factoring company might force you to commit to a long-term partnership with them. You don’t want to be tied down to something that you’re not entirely unsure of yet.

Ideally, you want to get into an invoice factoring agreement with a company that is open to a long-term contract but won’t force you to sign one before you’re ready.

Choose Volopay’s line of credit over invoice factoring

There’s no denying that invoice factoring can be a reliably quick alternative when you need funds on hand. You can get some cash almost immediately even without any credit scoring that you have to pass.

However, that doesn't mean that invoice factoring isn’t without its shortcomings. Not only can it have expensive fees that could lead to a smaller profit margin, but you’ll also run into the risk of ruining otherwise good relationships that you’ve built with your customers.

In the long run, it could have more negative than positive impacts on your business.

Still, that doesn’t always mean that getting a bank loan is the right option for you. In fact, it might end up being more detrimental for some businesses—or even not be a feasible option. In that case, you’ll need to look for another alternative.

Volopay offers corporate cards equipped with a line of credit that you can use to tide over your cash flow and help your business grow. The good news is that applying for a credit line with Volopay is nowhere near as tedious as applying for a bank loan.

You can get started in just a short time and you won’t run into the risk of hidden fees, either. With everything lined up for you upfront, you’ll be able to utilize your Volopay corporate cards with a credit line stress-free as soon as you get started.

Avail flexible business credit line from Volopay