When it comes to choosing the right factoring service for your business, it need not be complicated. All you need to do is establish what type of factoring you require, how many of your outstanding invoices you need funding and how much you’re willing to pay for this service.
But first, it’s important that you understand what factoring entails:
How does factoring work?
As an alternative method of financing, factoring enables organisations to sell their accounts receivable or invoices to a third party known as the “factor”. This then helps you to gather the necessary funds you need to keep your business moving while waiting for your outstanding invoices to be paid by clients.
In most cases, you won’t be paid the full amount for your invoices by the factor. Instead, you’ll be paid around 70% to 90% of their total value and often within 24 hours of the order being placed. The company will then chase your customers’ payments for you before forwarding on the amount to you (minus their fee).
Before they accept any of these invoices, the factor will check your customers’ creditworthiness to make sure they’re going to be able to pay their invoices on time. This is crucial because the factor won’t be operating as a collection agency, which is why your customers’ accounts will need to be in a good position.
Once your customers have been accepted, the factor will then check all the invoices are accurate and complete before sending the information to your customers. Your customers will then be notified that you’re using the factor’s service and that all future payments should be sent to them.
How to choose the factoring you need
When it comes to factoring services, there are two main types:
Recourse factoring: This is the most cost-effective type of factoring that’s more readily available. All your invoices will be funded by the factor for you but when an invoice remains unpaid, you will have to refund the factor for this. More competitive rates are available because you, as a business owner, are assuming more responsibility.
Non-recourse factoring: Here, you’re released from any liability for failing accounts with the factor taking on more legwork and responsibility for you. Because of this, you will need to be prepared to pay more for their services and the creditworthiness of your customers will be scrutinised more heavily.
How much can you afford to pay?
As you can see from the above definitions, the higher costs are involved in the factoring services that carry more risk. In general, most fees will be between 2% and 6% of your total invoice amount with this rate being determined based on your industry risk, customer base, billing structure and client credit history.
The amount you pay can also be determined by your invoice repayment terms. If you give your customers longer to pay their invoices, the fees may be higher. However, if you can prepay on outstanding amounts, the higher rate may only be charged on what’s left over.
To get the best rates, you’ll need to find a factoring company that’s suited to your business, its industry and budget. There are several services that help you to find these, including the Factoring Directory.
Finding the right factoring company for you
Before you go ahead with any factoring company, it’s important that you’ve done some thorough research. This involves finding the right service provider for your company and establishing whether factoring is the right process for your organisation.
One of the potential disadvantages of factoring is that it can end up more expensive than lending if you let the fees add up over time. However, this is often worth it for businesses who are seeking immediate capital and will be something you need to evaluate with your account’s team.
When reviewing the strategy, it’s important to look at this as something that’s going to be carried out over a certain period of time. Looking at it in this way will enable you to conclude whether you’ll be able to recover the costs and expand your business, achieving those long-term goals in the process.
In most cases, factoring proves to be beneficial for those companies whose client base is reliable and have a payment structure of net 30 or net 60. If your company isn’t financially stable, factoring is not the answer nor is it a good idea if you have fewer accounts receivable than accounts payable.
Factoring could or could not be the right solution for your business but it should definitely be a consideration if your day-to-day business operations are being hindered by invoices that are outstanding.
Daisy Matthews runs a growing giftware business which is now in its 5th year. At first, she tried to do everything herself but soon realised this wasn’t possible, nor productive. She shares her business experience with like-minded business owners.