Invoice factoring, as a service, exists specifically because it can be particularly helpful for smaller businesses occasionally suffering cash flow issues. FastFACTR, a company specializing in invoice factoring, says that small businesses are indeed ideally suited for using invoice factoring when and where it is needed. However, invoice factoring is, technically, a form of borrowing and so every business deciding to make use of it, big or small, should certainly run some numbers before taking the plunge. It is a fantastic service that has saved many small businesses from the proverbial grave, but you should always analyze your finances first to ensure that it is indeed cost effective for your business.
What is Invoice Factoring?
Before moving on to some advice on how to calculate the cost-effectiveness of invoice factoring, it is worth getting our definitions precise. Invoice factoring is there to answer cash flow issues. This implies that it is a means of acquiring the funds that you need now, on the full understanding that the money borrowed is indeed part of your “income” which has simply not come in yet. Accordingly, the repayment of an invoice factoring loan depends entirely on there being an invoice that guarantees a certain amount of funds are on their way in the form of a payment from a client or customer on a particular date.
Repayment is therefore not determined by interest, but merely a small fee, either flat or reckoned as a percentage of the invoice value. This means, of course, that invoice factoring is not free, but it can be very cost effective – if you budget properly.
When To Use Invoice Factoring
Perhaps the best way to determine whether invoice factoring is cost effective for your business then is to consider the different circumstances in which it can be useful. Here are a few:
To Avoid Other Forms of Financing
Sometimes your business is making enough money to cover all its costs, but it still has a cash flow problem. If this sounds like you, then invoice factoring is probably a safe bet. When analyzing its cost effectiveness for your business, you can add to your plus column the money saved on more expensive, interest-determined loans. Invoice factoring frees up capital and the cost can be easily offset as new client invoices are secured. However, you should always move towards solving the cash flow problem rather than relying indefinitely on invoice factoring.
To Reduce Bad Debts
In cases where an invoice payment is not entirely guaranteed, it is worth finding a non-recourse factoring service, where the company will bear the risk of a bad debt. In such cases, the repayment of the loan is dependent on the invoice actually being paid. In such cases, you can actually put more pressure on the client to ensure this happens, thereby slightly reducing the overall chance of bad debts for your company.
For Reducing Cash Flow Management Time
One situation where invoice factoring could well be cost effective at your business is in reducing the time it takes for cash flow to be managed. For example, managing cash flow when payment is not expected must be a complicated matter of analyzing payment dates with current income. By using invoice factoring to clear invoices quickly, you can simply spend less time doing this. And, as we all know, time is money.
Ultimately, invoice factoring is there to help small businesses. A bit of diligence and cost-effectiveness analysis is all that is needed to ensure that you use it responsibly and, therefore, profitably.