Invoice Factoring: A Beginner’s Guide

invoice factoring beginners guide

The best feeling in the world as a business owner is getting paid. The worst? Waiting to get paid. Whether it’s due to trade credit or delinquent customers, waiting on money is awful. That’s where invoice factoring from PayPie can help as a fast, effective way to free up cash tied up in unpaid invoices.

If you haven’t heard of invoice factoring before, it’s a well-established trillion dollar industry. (For history buffs: The earliest form of invoice factoring first appeared in the Code of Hammurabi from 1754 BCE.) For newbies and entrepreneurs who simply want to be informed — here’s what you need to know about how it works:

How invoice factoring works

Invoice factoring is a fairly simple concept: If a company has one or more unpaid invoices that due from clients, but hasn’t yet been paid to them. Invoice factoring lets businesses sell their invoices to lenders (factors) for the sum of their outstanding balances. You essentially borrow against your outstanding invoices in order to get your money faster — since the factor provides the cash instead of the customer. This creates more financial flexibility, all without a lengthy term-loan application process.

The factor holds onto the borrower’s invoices in exchange for a percentage of the total value of the invoices. The factor is then responsible for the collections process, typically by working directly with the clients who are paying for services. Once the factor is paid, the business receives the remainder of the balance — minus interest and fees.

The benefits:

  • By passing along invoices to a factor, businesses free themselves from lumpy cash flow due to piecemeal payments.
  • This further unburdens the business from being reliant accounts receivable in order to have working capital and cash flow.
  • The factor provides the money up front and handles the back-end work of collecting payment. 

Learn More: Six Reasons Businesses Use Funding 

Five ways businesses can use invoice factoring

Here are some examples of what businesses can do with the money they receive through invoice factoring:

1. Bridging cash flow gaps 

The most vexing issue with unpaid invoices is the uncertainty they create for your company’s cash flow. You know that you have money coming in, but you’re not sure when you’ll actually see it in your account. Invoice factoring helps you take the guesswork out of when you’ll get paid — making it much easier to keep your company’s cash flow steady.

By borrowing against the value of your invoices, you know exactly when you’ll have money in your account. Invoice factoring minimizes fluctuations in your company’s day-to-day finances, all while making it less of an imperative to chase individual invoices in order to keep your business running smoothly.

2. Accessing fast, short-term funding

Keeping your cash flow steady is great. But, sometimes, you need a little extra help with paying for bigger expenses as well, such as payroll or emergency repairs. Instead of panicking when you’re short on operational cash but big on unpaid invoices, you can use invoice factoring to help take care of the little (and big) things that keep your company humming.

Invoice factoring is usually a speedier process than obtaining a business loan or business line of credit. Those loans typically require collateral, extensive applications, and a lag between approval and the disbursement of funds. You can’t always wait that long if you’re short on cash to pay staff, replace broken machinery, or make an office repair.

growth opportunity

3. Using invoice factoring to access working capital

Your company’s cash flow and operational budgeting might be perfectly fine from month to month.  Better still, your clients might be super reliable about paying their invoices on time. But even if any of those factors are true for your business, there may still be moments when you can benefit from having a lump sum that’s delivered to you more quickly than your invoice terms allow.

In these cases, invoice factoring helps you move up the payment timeline. There are also no restrictions on how you use the money — since, in essence, it’s your cash in the first place. You’re free to use invoice factoring to increase the amount of liquid funds on your balance sheet and apply them how you see fit.

More Tips: 7 Ways to Boost Cash Flow 

4. Investing in growth

Another great time to pursue invoice factoring is when you’re ready to tackle a new project, initiative, or large order from an existing or new client. It’s not always easy to invest in the raw material, machinery, or inventory you need when expanding your business. But through invoice factoring, you can convert your existing accounts receivable funds into money that can be used for all of the above.

Even if you would not normally be in the market for invoice factoring, you can always call upon this resource when the unexpected (but exciting) prospect of future business or new initiatives comes around.

5. Building and preserving credit

Invoice factoring provides small business owners with an opportunity to get financing without impacting their credit rating, too. The money you get from invoice factoring a loan, since your invoices are the basis for the exchange between you and your factor. And, if you want to build your business credit, you’re free to use the money to pay off business debts. In these ways, invoice factoring helps you preserve or improve your credit.

What’s a Business Credit Report and Why Should You Care?

Three questions to ask when considering invoice factoring

If you’re considering invoice factoring, there are a few factors to consider. You’ll want to make sure you’re partnering with the right company, and on the right terms for your business. Here are a few of the big questions to consider before entering into an invoice factoring agreement:

1. What are your odds of loan approval?

It is typically easier to get approved for invoice factoring than for other kinds of loan products. With that in mind, you’ll want to consider whether or not you’re likely to get your business approved for other kinds of loans, or if your best bet is to pursue invoice factoring from the get-go.

If you’re considering working with a company, ask them which factors increase or decrease your risk profile, including years in business, previous credit history, the size of the invoices and the quality of your customers and their payment histories.

2. How will invoice factoring impact my client relationships?

Although invoice factoring is common, many factors require businesses to notify their clients about their partnership. Clients will pay invoices to the factor, rather than the business, which can sometimes require explanation and information. Not every small business owner wants to leave this component of their client relationship to a third-party, making a dialogue about invoice factoring beneficial.

3. Which invoice factoring company is right for my business?

Invoice factoring has been around for quite a while. In fact, it’s old enough to have seen a variety of industry-specific factoring companies flourish. Small businesses owners may not be familiar with invoice factoring companies, however, which means that it’s important to find one that has experience working within your field.

If you’re used to waiting 30, 60, or 90 days to get paid, but often need the money in less time than your terms allow — invoice factoring may help you create a steady cash flow, a consistent pool of operating capital, or even an additional source of funds to help take on the next big chapter in a business’ growth.

In addition to invoice factoring (coming soon), PayPie also offers insightful cash flow forecasting cash flow forecasting that includes drill-down screens for accounts receivable and credit risk insights (see below) that show small business owners how potential lenders might assess their company.

PayPie Cash Flow Forecast Example

All you need to do is sign up for a PayPie account and connect it to your QuickBooks Online account, and you’re good to go.

PayPie only supports QBO at the moment, but integrations with other accounting applications are coming soon. 

This article is informational only. It does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.

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