Editor’s note: Fundbox isn’t a factoring company, however, people often ask us what factoring is and how Fundbox compares. We asked Rieva to give us the breakdown on traditional factoring and how it works. To learn more about Fundbox, click here.
Is your small business in a cash crunch? If your business is one where customers receive services or products and are billed at a later date, you can often find yourself with a cash flow problem. Theoretically, you’ve got lots of cash—at least, if you count outstanding invoices. But if your customers pay net 30, net 60 or even 90 days, there can be a lengthy gap during billing and actually receiving the money. This can hinder your ability to take advantage of opportunities or even pay your bills.
When you’re in this situation, factoring may seem like a smart solution. Factoring allows you to get paid for your outstanding invoices immediately, instead of waiting for customers to pay you. Here’s how factoring works:
A third-party company, the factoring company, will purchase your outstanding invoices for a percentage of their value. You get this percentage (typically between 80 and 90 percent) immediately. The value of the invoices may be affected by whether they are past due or not; companies will typically pay less if they believe there is less chance of actually collecting on the invoice.
The factoring company takes over all collections for the outstanding invoices, contacting your customers to follow up and obtain payment. Once the invoices have been paid in full, the factoring company will give you the remaining percentage owed on each invoice, minus any fees or charges for their services.
Factoring offers a couple of benefits for small business owners facing cash flow issues.
- If you are spending a lot of time dealing with customers in order to get paid, having a factoring company take over the collections aspect can free up time to focus on other parts of the business.
- You get your money immediately, which enhances your ability to grow the company, pay your bills and maintain a high credit rating for your business.
Of course, factoring has some serious downsides you need to consider as well.
- You never get the full value of your invoices, because the factor’s fee will always be deducted from what you receive. As a result, factoring works best for businesses with high profit margins that can afford to lose a percentage of what they are owed.
- Your clients may be confused when the factoring company contacts them to obtain payment. This confusion can result in even more delay. Also, clients may worry about your company’s stability when they find out you are factoring your invoices. Do you really want clients knowing this much about the internal functions of your company?
If you like the idea of getting paid for invoices immediately, but don’t want a third party coming in between you and your customers, invoice financing, like that offered at Fundbox, can be a better solution than factoring. In invoice financing, you get the value of your invoices immediately. However, you remain in charge of collecting on the invoices, so your customers never know about your cash flow concerns. You also receive 100 percent of your invoice value, instead of having to sacrifice a percentage to the factoring company.