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Small businesses needing financing will often look at invoice factoring as an option, but wonder if it’s worth it compared to other kinds of cash injections like lines of credit or other bank loans. Factoring is faster than waiting on bank loans or credit card approvals, but there are considerations like costs, the option for spot factoring (i.e., choosing the invoices to fund) and customer perceptions to think about.
If you need a primer on invoice factoring, see our article on what factoring is and how it works. In this piece, we’ll help you go over the benefits of invoice factoring (including a few you might not have considered!) and guide you on selecting the best factoring company for your needs–all to help you decide for yourself if you should factor invoices.
Should I use invoice factoring? Is invoice factoring worth it?
The short answer is yes. Here’s why:
Invoice factoring is worth it if you’re grappling with cash flow issues because unlike other financing, it’s designed to solve that specific problem. At the core of many cash flow problems are extended net terms, which factoring addresses directly with immediate access to funds you’ve already earned–rather than adding more debt to your balance sheet. With that said, how valuable it is hinges on your specific needs and the factoring partner you choose.
According to the Service Corps of Retired Executives (SCORE), cash flow and costs are the top challenges faced by small and medium-sized businesses today. Furthermore, the average daily income for small businesses is just $7 above the operating line; achieving predictable cash flow can seem like a distant dream for many. It would be impossible to invest and leverage growth opportunities with such limited cash flow. Even funding day-to-day business operations would be challenging.
If you’re a B2B business and any of the scenarios below resonate with your current situation, you might want to consider factoring as a solution:
- Business Growth or Upcoming Projects: Expansion and new projects demand significant capital. Factoring converts outstanding invoices into instant cash, fueling your growth without the wait to get paid or get raise a line of credit limit.
- Payroll Needs: Meeting payroll is non-negotiable. Factoring ensures you have the necessary funds on hand, maintaining your team’s trust and morale.
- Seasonal Fluctuations: For seasonal businesses, cash flow can be unpredictable. Factoring stabilizes your finances by providing cash when you need it, ensuring smooth operations year-round.
- Unexpected Expenses: Emergencies don’t wait for convenient timing. Factoring offers quick cash to tackle unforeseen costs, keeping your business resilient
- Boosting Cash Reserves: Enhancing your balance sheet with more cash make your financials more attractive to investors.
- Cash Flow Stress: The anxiety of managing cash flow distracts from strategic goals. Factoring alleviates this stress by ensuring steady, predictable cash inflow
All of the above are situations in which funding is needed to grow or remain in business, but cash flow challenges stand in the way. See invoice factoring examples for how factoring helps in these situations.
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5 Questions to Help You Decide if Factoring is Right for You
If you’re having a cash flow crunch, invoice factoring will help. These five questions will guide your thoughts on how much invoice factoring will help you:
- Do you need a cash injection quickly? A bank loan takes weeks, and sometimes months, to process, with no approval guarantee. In fact, recent data from the Federal Reserve highlights that US banks have tightened lending standards. Meanwhile, working with a factor company can get you quick access to capital by funding invoices in a few business days.
- Do you need flexibility in when you can get funding? Lines of credit or business loans can look more flexible than they are. Traditional forms of credit exclude many types of businesses (like new businesses), require stellar credit scores to pass credit checks, and take weeks to process. Even raising the limit on an existing line of credit can be difficult. With invoice factoring, you can get funded whenever you need it, and you can do it with no credit or bad credit. (And with FundThrough, the flexibility includes unlimited funding.)
- Do you want to retain ownership in your company? Non-dilutive funding like invoice factoring ensures you never have to give up ownership in your company. But other forms of financing may require an equity stake. If you want to maintain complete control of your business while seeking quick capital for tapping into new business opportunities, then invoice factoring can be a promising option.
- Do you want to avoid debt? If you’re already carrying debt, invoice factoring won’t add to it since your creditworthy customer pays the factoring company.
- Do you want to avoid long-term commitment? Once your client clears their invoice payments to the factoring company, the process is complete – depending on the factoring company. Some require long-term contracts, while others allow you to choose the invoices you want to fund. Make sure to look for this in any invoice factoring agreement.
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The Hidden Advantages of Factoring
While many benefits of factoring are obvious, these are a few of the lesser-known value-adds of factoring invoices:
- Reduced administrative costs. This is about not having to manage A/R. Depending on how much of your A/R you factor, you could reduce or eliminate the need for an A/R specialist, making the fees pay for themselves.
- More time for strategic priorities. Because you aren’t having to manage cash flow as tightly
- Assistance with collections. If a customer doesn’t pay, a quality factoring company will work with you to collect on the invoice while maintaining your customer relationships. Oftentimes, an entire skilled team is ready to help, saving you time (and even money if you would’ve hired a collections company.)
- Option to pass on the fees. Some FundThrough clients have negotiated to have their customers pay factoring fees as part of the contract for long net terms.
- Customer credit checks. Since factoring companies use publicly available data to assess your customer’s creditworthiness (because they are paying back the advance), you can get an idea if extending credit to them is a good idea to begin with.
What are disadvantages of factoring?
On the flip side, it’s also important to consider the disadvantages of receivable financing in the context of your business’ situation:
- Can appear expensive. Invoice factoring rates vary a lot between 1% and 6%. Some companies might have a low rate, but have hidden fees that add up quickly. Some examples of this are application fees, service fees, termination fees, transaction fees and other related costs. You’ll need to think about the total cost of each company as you shop around.
- Concerns about business reputation.There can be a stigma attached to invoice factoring. The misconception is that the businesses using a factoring partner are in a bad situation financially, and many business owners worry about what their clients will think. But you should know that the opposite is often true: Business owners tend to use factoring to get funding for growth opportunities. In addition, many businesses, especially large businesses, and ones in industries where factoring is common (like staffing or oil and gas), redirect payment to factoring companies all the time.
- Concern over customer relationships. Some factors in the past left a bad impression by hounding their clients’ customers for payment, damaging valuable customer relationships. This understandably worries business owners, since collecting payment from customers is a delicate process. (You can see how we treat your customers if this is a concern.) This is a critical point to investigate when you’re reading reviews and talking to different factoring companies.
- Can be difficult to account for in bookkeeping.It can be confusing to record factoring transactions in your books accurately. Many accountants and bookkeepers aren’t familiar with how to add factoring transactions into their payment process. The good news is that it isn’t as complex as it appears. Our step-by-step guide can help. It’s specific to Quickbooks, but the basic principles apply to any accounting software.
These concerns are valid, but many of them are larger-than-life myths. The cost of factoring doesn’t have to be expensive, and it doesn’t have to affect your customer relationships. It takes a little leg work, but you can find factor rates that make sense for your company and an invoice factoring company that collects payment from customers professionally.
How to Choose a Partner that Will Make Factoring Worth It
Finally, if you’re looking for the answer to whether factoring is worth it, the factoring firm you choose heavily influences the value of your experience. You can get a detailed comparison of several factoring companies in our best invoice factoring companies post, but here are is our list of what to look for in any partner you’re considering:
- Cost. This isn’t just about the discount rate – the percentage the factoring companies keep as their factoring fee – it also includes hidden fees. Make sure you understand the entire cost for any company you’re considering. FundThrough only charges one flat fee.
- Advance rate.This is the amount the factor advances you. Some companies only advance 80% to 85% of an individual invoice and give you the rest once your customer has paid. FundThrough advances 100% of your invoice less our fee.
- Speed. One of the most important advantages of factoring is that it’s fast. Make sure any company can give you an advance in days, allowing you to resolve immediate cash flow issues quickly. FundThrough pays invoices in days.
- Application process. The funding process should be short and easy so you can get back to business. What makes a fast application process? Technology. For example, FundThrough uses AI, automation, and integrations with accounting platforms like QuickBooks and OpenInvoice to eliminate time-consuming paperwork and make faster decisions.
- Total flexibility. Some factoring companies make you commit to factoring all your invoices for one customer, or to funding a minimum dollar amount every month, or hamper your funding with a limit. FundThrough lets you choose which invoices you want to fund with no minimum monthly funding requirements; we also provide unlimited funding.
- Dedicated customer service. It can help to have an account manager who will get to know you and your business over time, so that they can take a consultative approach, proactively working with you to ensure you have funding for any upcoming needs. Be sure to ask any factoring company you’re considering about their level of customer service.
Is invoice factoring worth it? The bottom line
In short, invoice factoring is worth it if you’re facing cash flow challenges. It offers a quick and straightforward way to boost your working capital. Keep in mind everything we’ve discussed to help you decide just how beneficial it could be for your specific situation.
Ready to see if invoice factoring is right for you?
FAQs
Invoice factoring can be an excellent solution—especially when maintaining a consistent cash flow is crucial for your business. Invoice factoring transforms outstanding invoices into immediate cash, ensuring that your cash flow remains steady. This is particularly beneficial for B2B companies that often have to wait longer periods for payment. It’s a smart move if you’re looking for an efficient way to manage your finances without taking on traditional loans, keeping your cash flow robust and predictable.
Small businesses should consider invoice factoring risks, including: damage to client relationships, high fees and chargebacks from late payments, wasted money in fees to meet minimum funding requirements, and bookkeeping errors from incorrectly recording factoring transactions.
The perceived risk in invoice factoring largely depends on the creditworthiness of your customers. If you have confidence in your clients’ ability to pay, factoring should not introduce significant risk. Non-recourse factoring can further mitigate this risk by transferring the credit risk associated with client non-payment to the factoring provider, safeguarding your business against potential losses. However, non-recourse factoring can often be more expensive than recourse.
Working with a factoring company is advisable if you’re experiencing a gap in cash flow due to unpaid invoices. Factoring companies offer a cash advance against your accounts receivable, giving you immediate funds to cover operational costs or invest in growth opportunities. This financing option is particularly attractive compared to traditional business loans, as it offers a quick, flexible cash infusion without adding debt to your balance sheet. Choosing the right factoring services can ensure a steady cash flow, making it a key solution for businesses in need of immediate financial support.
Factoring companies are worth it if you need immediate access to funding for growth, payroll, or any other business expense. However, factoring companies also offer additional value: as a partner to your business, they can manage your accounts receivable and collections, check your customers’ credit, and help you proactively manage cash flow.