7. Invoice factoring advantages and disadvantages?
Financing invoices can be very beneficial. While all companies have different problems, most problems do revolve around cash flow shortages due to extending credit to customers. Below, you’ll find a comparison between invoice factoring and bank financing.
What are the Advantages of Invoice Factoring?
If a business is selling on credit terms, invoice factoring is the best option because the funding grows with your sales as long as you are selling to creditworthy accounts. Factoring companies continually monitor credit on your customers so it's like having an added value service to make sure you don't sell to delinquent customers.
3 to 5 Day Account Set-Up – A factoring company can set up a client in approximately 3 to 5 days.
Start-up Business Approved – Factoring invoices is a transaction type of finance, so there is no need to review financials, debt ratios, sales histories or other typical underwriting parameters that you’d see used in the banking world.
Fast Approvals – Prequalifying a factoring client is very simple and straightforward. Usually, a client can get pre-qualified in one hour and get the initial funding in 3 to 5 days. Once the client is set up, funding usually occurs within 24-hours of submitting an invoice.
Account debtors with no payment history, slow payment reporting or a poor financial status will not be eligible to factor. It is important to sell to credit-worthy accounts if you plan to factor invoices. On another note, if you are selling to non-credit worthy accounts it may be only a matter of time before you take a loss.
Higher Credit Limits – A credit limit is not established based on past history or debt-to-income ratios like a bank. An invoice factoring company establishes the credit limit based on the credit-worthiness of the account debtors rather than the client’s ability to pay. The client will request an estimated credit limit for each account based upon what will be needed in the future.
Credit Analysis – One of the services offered is advising the client of credit risks for each account. A bank offers no credit risk reporting or analysis of accounts.
Opens Up Additional Financing Alternatives – Once a factoring company establishes a relationship, other additional financial products may become available to that client. These include purchase order financing, inventory financing, and/or letters of credit to vendors.
No Financials Required – Financials are typically not required under $350,000, but this may vary from factor to factor. This is a huge advantage, since most small businesses do not have full-package financials.
Location is No Longer an Obstacle – Banks require regional locations and physical visits. Setting up a factoring relationship is a phone call away and you can do it from any location in the country.
No Audits – Banks need to send an auditor. The majority of factoring companies do not require audits unless you’re requesting a substantial amount of money.
Instant Access to Deposited Checks – Checking accounts can take up to 3 business days to credit your account. Factored invoices are immediately available because the funds are wired or deposited into your checking account via ACH.
Invoice Factoring is Not a Loan – When a company submits an invoice for funding the invoice itself is an asset. The factoring company is simply purchasing the asset at a discount. The client who issues the invoice is the seller, and the factoring company is the buyer. The transaction is treated like a purchase and not like a loan. The balance sheet shows cash on hand. It’s not a liability that must be paid back like a bank loan, as if the transaction were a cash-on-delivery sale.
International Receivables – Foreign receivables become eligible when you use an international factoring company.
Credit Scores – Most factoring companies do not make approvals based upon the personal credit score of business owners. Decisions are heavily weighed on the quality of the account debtors and on having clean paperwork with back-ups.
What are the Disadvantages of Invoice Factoring?
No solution is perfect, and invoice factoring does come with some disadvantages you should be aware of. Invoice factoring involves a three party relationship and your customer needs to understand in order for you to be able to offer credit terms you will have to borrow against the invoices. The number one concern applicants have is the perception the customer will have once they find out they are needing to factor the receivables.
Factoring Company Interaction – There will be more interaction between the factoring company and the account debtors. Clients sometimes feel uncomfortable about this at first. After awhile it usually becomes “business as usual.”
Discount Fee – The fee is more expensive than a bank loan. However, the fee is based on every transaction, and is only charged when a transaction takes place.