Business Advice/Guide

Risks Of Typical Business Factoring [And Why Invoice Finance Is A Better Route]

Business factoring is a form of small business finance that’s becoming increasingly popular. It’s a great way to increase your cash flow without taking on large, expensive liabilities in the form of traditional bank loans.

But what exactly does business factoring mean for your business? And what’s the difference between invoice factoring and invoice financing?

TL;DR

Business factoring is a good way to improve business cash flow, but it’s also inflexible and it can impact your relationships with your customers. Invoice financing works in a similar way, but allows business owners to keep more control over their invoicing and payments process.

Importance of cash flow for businesses

Cash flow is one of a few critical metrics that keep your business alive. Of the businesses that fail, 82% of them do because they have cash flow issues. 

Cash flow is the cash you have available at anyone time.  It is what enables businesses to pay bills and staff, purchase inventory and reinvest in their growth. 

The reason why cash flow is relevant in business factoring and invoice financing is because invoicing isn’t actually an efficient way to bring in money. It can take weeks, or even months, to get paid after doing a job. 

There are all sorts of expenses and overheads due in that time, and if the business doesn’t have the cash on hand to cover them, it puts a lot of pressure on. All it takes is a few customers to be late paying their invoices to place a perfectly functional business in jeopardy.

This is perhaps the biggest reason why more businesses are using invoice finance as a form of cash flow.

Understanding business factoring

So how does business factoring actually work, and how does it help you? 

Businesses use factoring to essentially get an advance on their invoices. Rather than waiting for your customer to pay the invoice, a business factoring service will purchase the invoice off you. They’re also known simply as the factor.

The factor will usually pay 80-90% of the value of the invoice, and make up the difference (less a fee) when your customer pays it. 

Here’s where it makes such a difference:

Say you have a $15,000 invoice that you send to a customer. It’s due in 30 days. In that time, you have to pay rent, wages and a power bill, among other operating costs. You also have another job that you have to purchase specialist equipment or supplies for. 

If you don’t have enough money in the bank to pay for all those things, you may have to turn down that job, even though it’s a lucrative one. The thing is, if your customer paid that $15,000 invoice then you WOULD be able to afford it.

However, by using a factoring for business service, you can essentially get the bulk of that invoice paid in quick time, so you have the money on hand to cover everything that’s due.

This is one of the great advantages of business factoring, and shows how it enables businesses to grow.

Risks of typical business factoring

Small business invoice factoring is not a risk-free lending service for businesses. While it does have advantages over other borrowing schemes, there are a few fish hooks to consider.

Loss of Control

When using invoice factoring solutions, businesses give up control of their own invoices. The factor commonly takes on the invoice as if it was its own.

That means you give up an element of control over your customer relationship. If your customer is late to pay the invoice, often the factor will be chasing them up. The way they deal with your customer may have an impact on your own customer relationships. 

Recourse

In the invoice factoring industry, there are two types of schemes: recourse factoring and non-recourse factoring.

They deal with who has the ultimate responsibility to chase invoice payment. 

Recourse factoring is where the seller (i.e. your business) is responsible for ensuring invoices are paid. Non-recourse factoring makes getting payment the factor’s responsibility. 

Under a recourse arrangement, you can be charged late fees and interest on outstanding balances, not to mention having to spend time chasing up payment. 

Customer Perception

When you first start to use business factoring, you need to change the bank account on your invoices. Your customers will be paying the Factor directly.

This involves telling your customers to edit their records and gives away that you’re using business factoring. For business owners that prefer to be discreet about their financing, this may not be ideal.

At the same time, customers may come to their own conclusions about why you’re using such a form of finance. In a worst case scenario, they may perceive you to be struggling with cash flow and decide it’s risky continuing to do business with you.

Sales impact

The impact of business factoring can be felt in other areas of the business. 

For example, to satisfy the factor’s requirements for lending, you may need to reduce your payment timeframes or credit limits you offer customers, or even if you can offer credit at all to some customers. This may impact your sales. 

Commitment

There’s often a high degree of commitment required to take on business factoring. Factors usually insist on being used for all your invoices, even if you only want it for some of them.

Often, businesses look for factoring to cover only enough invoices to provide the cash they need at the time.  They don’t want to be paying fees on all of thier invoices, or at a time when they do not need the cash. Factors generally don’t offer this type of flexibility. 

Mitigating risk of factoring with invoice financing

Now that you know the risks of business factoring, what can you do about them? Fortunately, invoice funding helps businesses overcome a lot of the challenges of factoring.

Read more: The differences between factoring and invoice financing

This is how invoice financing with FundTap deals with the risks discussed above:

Loss of Control

With FundTap, your customer will never know you’re using invoice financing. Customers still pay invoices into your own bank account, and you repay FundTap automatically from that point.

FundTap doesn’t chase invoices on your behalf, and will never contact your customers. This means you keep full control over your customer relationships.

Recourse

As above, the responsibility of getting invoices paid rests with you. With late invoice payments, one of the biggest pressures is having the cash flow to fund what needs to be funded. 

Invoice financing relieves that pressure, but you are still required to follow up late payments with your customers.

Customer Perception

Quite simply, there is no change to the way customers perceive you when you use invoice financing; they don’t even know you’re using it.

Sales impact

Getting credit approved with FundTap is easier than with business factoring, as well as many other invoice finance services. With FundTap, you can have credit approved in as little as one hour.

There’s no need to adjust any of your own business processes, which means your customers aren’t impacted and neither is your revenue.

Commitment

This is where FundTap really stands out from all other business factoring AND invoice financing providers. Where others require businesses to use them for all of their invoices, FundTap has unrivalled flexibility. 

With a FundTap account, there is no obligation to use invoice financing on any invoice. You can use it whenever you like, with no penalty. If you don’t need it one month, great – don’t use it.

This helps to keep costs down while also providing security that you have a service that’s available to improve cash flow when it’s needed.

Differences between factoring and invoice financing

As well as what we’ve mentioned above, there are a few other differences between factoring and invoice financing. 

Because many invoice finance companies have different aspects to them, we’re using FundTap’s approach to show the advantages of invoice financing.

  • Fees. Business factoring typically charges between 2-4.5% of the invoice amount per month, but this is often only one of the fees you will need to pay. When you add them all up they can get expensive and you will likely be paying even when you don’t need factoring. FundTap’s fees start from 4% of the value of the invoice, but there are none of the establishment, admin or system fees that other providers charge. Unlike others, FundTap only charges a single, transparent fee.

You can calculate the cost of using FundTap for invoice financing here.

  • Usability. Where business factoring is rigid and inflexible, FundTap allows users to select which invoices they want to be paid. FundTap fully integrates into your online accounting system, which means applying for financing is a simple case of selecting the invoice and submitting it from your dashboard. 
  • Speed. It can take up to two weeks to get funding with some of the best invoice factoring companies. With FundTap, you can have an account set up in five minutes, credit approved in an hour, and funding in your account the same day you apply for it. 

The bottom line

Business factoring is a great way to improve your cash flow, but your business can benefit from debtor finance in much greater ways. 

Without the extra risks, costs and inflexibility, businesses can use FundTap to unlock their maximum potential. On average, FundTap customers have grown revenue by 54% over the past two years, which shows how well it works. 

FundTap is the best invoice financing option when it comes to ease, convenience, cost and flexibility. All of these features are designed to help time-poor business owners to get the cash flow they need with the minimum of fuss.

Find out more about how FundTap works, or check out a free demo today. 

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