Until today, cash flow problems remain the greatest concern among small and mid-sized business owners. Startups and small businesses are conversant with the difficulties of getting a bank loan. Traditional and bank lenders require a business proof of viability to give out loans. Besides, they are reluctant to lend to businesses with poor credit scores, low income and a few years in operation.
To improve the chances of approval, you must be in business for many years to build a strong credit score and maintain positive cash flow. These requirements leave small business owners with not so many loan alternatives to go for. Luckily, there is a viable funding option that many small business owners don’t know yet- invoice factoring.
Invoice factoring defined
Business owners need sufficient working capital to stay updated on the evolving market. Nevertheless, some businesses don’t have enough to meet their daily expenses. If you want instant cash and you have various unpaid account receivables, you may need to try invoice factoring.
Invoice factoring allows small business owners to sell unpaid invoices to factoring companies for instant cash. In most cases, factoring companies fund 80-90% of the total accounts receivable value. Then, the remaining amount goes back to the business after they deduct their fees.
To understand invoice factoring and how accounts receivable work, and even the role of factors, read through!
An account receivable, also called an invoice, is cash owed to your company after delivering products and services to your customers. Once you make the sales, you can send the invoice to your clients indicating the payment terms.
The invoice duration takes from 30-90 days. After the term comes to an end, the clients should pay the money they owe. Nevertheless, small businesses and startups don’t have the luxury of waiting for 30 days to get paid. Provided a business is operational, expenses will continue piling up. Invoice factoring for startups allows entrepreneurs to sell unpaid invoices in exchange for instant cash.
For entrepreneurs, your account receivables are as good as money. It’s an instant cash resource you can rely on at any time. After selling the account receivable to your preferred factoring company, you can use the cash for daily expenses instead of waiting for months.
Factoring companies are third-party lending institutions that buy account receivables at a discount. However, you need to know that your clients will find out when you take an invoice factoring. Rather than paying your business, they will remit payment to the factoring company.
Here are the things a factoring company will consider before they buy your invoices
Personal and business credit rating. Even though your client’s credit score has more weight, the factoring company must conduct some due diligence.
Customer credit score. The factor needs to make sure that they are financially reliable to pay for the account receivables.
The number of years your business has been operational.
If you have a robust credit score and stable relationship with creditworthy customers, factoring companies will consider you lower risk and offer you good terms. So, higher risks attract high-interest rates.
Advantages of invoice factoring for small business
One of the noteworthy benefits of invoice factoring is it’s not an ordinary bank loan. Technically, it’s not a loan. With factoring, you get an advance of the cash you are owed.
- Other advantages of factoring include
- Getting working capital without incurring debts
- Faster turnaround
- High chances of approval
Why your clients might love invoice factoring
Despite the numerous advantages of invoice factoring, there are small business owners who might be hesitant to try. That’s because they are concerned with their business reputation and the impact it might have on client relationships.
Some entrepreneurs think that if they sell their account receivables to factors, their suppliers and clients will think the business is going down. Another issue is that factoring accounts receivable might be detrimental to client relationships due to factoring the company’s workflow on payments.
But that’s not true since invoice factoring can improve the relationship you have with clients. Here is why:
- Streamlining the account receivable process
- Payment collection is handled by experts
- Improve company’s growth