Cash flow is a critical component of business, especially if you are starting out. In addition to meeting payroll and paying suppliers, funds are needed to reinvest in the business. Newer companies may not have a line of credit or ample savings to meet expenses.
One way to boost cash flow is through invoice financing. Also called invoice factoring or accounts receivable financing, this method is used by businesses who don’t want to apply for traditional financing.
How Does It Work?
Businesses that perform this type of financing are called factoring companies. They advance 85 percent of the value of past-due invoices to the company, with the remainder due at a later date. Factoring companies charge the borrower a percentage of the total invoice amount. This allows businesses to continue operations during times when cash flow is low.
Advantages
Many startups find it difficult to qualify for traditional lines of credit, so invoice factoring is an attractive option. The financing company is primarily interested in the creditworthiness of your customers, so your credit rating is not a gating factor.
The process of establishing invoice factoring is quick and easy, so you can get on with your business. A predictable cash flow will allow you to take advantage of business opportunities without having to worry about paying the bills. Additional cash can also help you finance expansion projects or enhanced R&D efforts.
In some cases, factoring companies will assume the task of collecting unpaid invoices. If any of your customers are late, they will focus on obtaining payment while you concentrate on growing your business.
Disadvantages
While invoice financing allows you to have access to cash quickly, there is a cost associated with this type of loan. Fees range from 1 to 5 percent of the invoice amounts along with an annual interest rate between 12 and 60 percent. Since there is a risk that customers may not pay their bills, businesses should be confident that the cost of financing makes sense.
Customers of businesses that use accounts receivable financing may not be happy about having to interact with a third party in the transaction. They might not want their proprietary information shared with another business.
Who Should Use Invoice Financing?
Invoice factoring is ideal for companies that work with businesses that have 15 to 90 day payment cycles. Marketing companies and public relations firms are examples of businesses that benefit from this approach, since they typically have unpredictable cash flow and long engagement cycles. Small companies and startups usually pay higher rates than larger, established businesses.
When you are growing your business, you shouldn’t have to worry about cash flow. Take some time to see if invoice financing is right for you.
