Invoice factoring is a way through which businesses who sell goods or services to other businesses or the government get access to funds when cash flow becomes irregular. It involves the selling of invoices issued to a factoring company who goes ahead to collect the sum of the invoice factored from the customers. Typically, like every other method of financing, this approach has its pros and cons.
1. Credit Scores
Unlike traditional small business loans which require stiff credit scores, invoice factoring does not. Their interest is the creditworthiness of the customer who was invoiced as well as the invoice value. As a result, its credit standard is easier.
2. Quick Cash
Banks and other traditional lenders do not make cash readily available compared to factoring companies who can advance cash within a 24-hour window. This is the kind of solution businesses in need of cash flow require when payments from customers get slow.
Small businesses can focus their energy on other aspects of the business rather than spend it chasing down customers who owe them in order to raise funds. Besides, they gain access to funds without losing their equity.
4. Business Ownership Retention
As mentioned above, invoice factoring offers small businesses an opportunity to raise funds without any fear of permanently losing ownership control of their business.
1. Reliance On A Customer’s Credit Worthiness
Your business may be creditworthy, but you may not have access to funds through invoice factoring because of the poor credit rating of your customer. Having to rely on someone else’s credit rating can be a drag on certain occasions. Even if your request is approved, you may end up being charged higher rates.
2. Costs and Fees
Factoring companies charge between 1 to 4 percent on the value of an invoice plus interest for the cash advanced, processing fees, and application fees. This does not make it the cheapest way of funding a business. In some cases, you may be expected to pay additional fees should your customers fail to pay up early.
Some customers may see this to mean that your business is desperate for cash and only end up scaring them. The assumption is that only a weak company will turn over its invoice to a factoring company.
These are some of the pros and cons of using invoice factoring as a method for funding a business when cash flow becomes irregular.