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Which type of invoice factoring is right for your business?
Invoice factoring could be an efficient way to improve your cash flow, but do you know what type will best suit your business?
Invoice factoring lets your your business unlock money your clients owe by selling their invoices to a third party for a fee. It can be a great source of working capital, especially if your business is in an industry that has a hard time getting a loan. But there are several different types of factoring to choose from — and not all are right for every business.
First, what exactly is invoice factoring?
Invoice factoring is a type of business financing in which a business sells their unpaid invoices to a factoring company at a discount. The company typically gives businesses between 80% and 95% upfront and then the rest of the funds after your clients pay up — with a fee subtracted.
Businesses can use their funds for any legitimate purpose like working capital. It can be expensive, so you might want to consider less costly financing like equipment loans if they're available to your business.
Is invoice factoring the same as invoice financing?
It isn't. Invoice factoring technically isn't a loan. Instead it's an advance with a two-step process that doesn't involve repayments or interest. When you sign up for invoice factoring, the factoring company typically handles invoice payments from your clients and gives you the funds after your clients pay up.
On the other hand, invoice financing is a secured business term loan backed by your business's unpaid invoices. You repay it in installments over a set period of time with interest and fees. And you're still in charge of collecting on your invoices.
Three types of invoice factoring to compare
Sell all of your invoices to a factoring company over a period of time.
Sell only the invoices you choose over a period of time.
Sell individual invoices in a one-off deal.
Compare business loan providers that offer invoice factoring
This is a popular choice for companies that are expanding and want a long-term solution for their invoice factoring. With whole turnover factoring, businesses are typically required to sign up for at least 12 months of factoring on all invoices they receive during that period. Since you're signing up for the long haul, many factoring companies often charge lower fees for whole turnover financing.
- Lower rates and fees than shorter term factoring arrangements.
- May provide additional credit and debt collection services.
- Less flexibility, invoices are typically financed in the order they're received.
- Locked into a contract for at least a year.
Selective invoice factoring
Selective invoice factoring lets businesses choose which invoices they want to factor and which they'd like to handle themselves. It allows companies to account for a number of factors that can affect income — such as the time it takes individual customers to pay invoices, peaks in trading and unique agreements with specific customers.
Like whole turnover factoring, selective also usually involves a year-long contract. However, it gives you the option to choose which invoices you finance and when. These features makes this brand of factoring a sound option for small businesses who deal with a diverse array of clients and customers. But it can be more expensive.
- Save by leaving out invoices they expect to be paid quickly.
- Maintain your relationship with some customers.
- Typically higher rates than those offered by whole turnover factoring.
- Doesn’t allow for the same hands-off approach as whole turnover.
If your company needs income quickly, possibly to cover a one-time payment or meet the monthly payroll, you might consider spot or single factoring. This is for when you’re looking to access the funds from one invoice or a single load as quickly as possible.
Keep in mind that the speed of this type of invoice factoring is reflected in the costs, which are the highest out of these three choices. The short period makes this type of invoice factoring less profitable for the lender, who may charge you weekly or even monthly for just a few hours of work.
- No long-term commitments.
- Choose when you want to sign up for factoring.
- More costly than other types of factoring.
- Not as common as whole turnover or selective factoring.
The type of invoice factoring that's right for you on the size of your company, your relationship with customers and how heavily your business relies on invoices for cash flow. Invoice factoring can offer efficiency and value that other business lenders don’t.
But that comes at a price. By choosing the best factoring company for your business, you can improve your cash flow and keep your customers happy.
Don't want to sell your invoices? Explore other business financing options.
Frequently asked questions
What happens if my clients don't pay on time?
It depends on whether you have recourse or nonrecourse factoring. With recourse factoring, it's your business's responsibility to cover the cost. With nonrecourse factoring, it's the factoring company's responsibility.
Typically recourse factoring is less expensive than nonrecourse factoring, since it's less risky for the lender.
How do I use invoice factoring if my business has inconsistent cash flow?
Factoring companies don't typically look at your business's cash flow when you apply as a business. If your business consistently struggles to cover overhead costs because of its cash flow, you might want to consider whole turnover factoring — you'll likely get a better rate than with any of the other options and have more consistent access to capital.
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