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Startups and struggling small businesses often experience cash flow issues at some point in their lifetime. When cash flow is an issue, many companies resort to external business financing. However, financing is difficult to obtain from banks or other traditional lenders when cash flow is an issue. These businesses often turn to alternative financing solutions when a traditional lender is not an option. A possible alternative is working with a factoring company which is among the lesser-known financing solutions. Factoring companies work with other businesses that have cash flow problems and purchase their accounts receivables.
To learn more about invoice factoring, what it is, how much it costs, and factors to consider when working with a factoring company, continue reading below.
A factoring company works with other companies that have cash flow problems, due to slow-paying customers and long payment terms, by purchasing invoices. It is important to note that factoring companies are not in the business of lending money. They purchase accounts receivables, or invoices, from their clients and earn a small profit.
Invoice factoring is actually a simple process. A factoring company purchase accounts receivable in two installments. The first installment is extended to the client the moment the invoice sale is complete. The first installment will be 70% to 90% of the invoice amount, the exact percentage varies by industry and factoring company.
The second installment is extended when the accounts receivable is collected. The payment will be the remaining 10% to 30% that was not paid in the initial installment less the financing fee of the factoring company. The customer does not need to pay sooner, they can pay at their regular pace.
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Unfortunately, there will always be a case or two where the accounts receivable is never collected. This would mean that the client would be unable to repay the factoring company. How these circumstances are handled depends on the terms within your invoice factoring agreement. There are two types of methods: recourse and non-recourse accounts. Let’s explore both below.
If the terms of your agreement are non-recourse, the responsibility to collect delinquent accounts is with the factoring company. If the factoring company can’t collect, they take the loss and the client is not penalized. This is a favourable option for the client because money from the factoring company can be spent freely without having to worry about delinquent accounts.
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If the terms of your agreement are recourse, the responsibility to collect delinquent accounts could fall on the client. In some instances, this is the only type of agreement factoring companies offer. In other instances, the recourse account might pay a larger percentage of the invoice value due to the added security of the factor.
Under recourse accounts, the client can buy back the invoice from the factoring company and try to collect on their own. Under this option, there are several possible legal actions you can take to collect a significantly overdue debt. If you don’t have the funds available to repurchase an invoice, you can swap invoices with the factoring company. The new invoice will replace the amount of the delinquent invoice, then you can attempt to collect a debt.
Virtually anyone can work with a factoring company where goods and services are sold on account with net 30 to net 60 payment terms. Some industries use factoring companies more than others, below is a list of industries that commonly use factoring.
As with any form of financing, there are various pros and cons to consider before making a final decision to proceed. Let’s explore the advantages and disadvantages below.
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Working with a factoring company is ideal if one or more of the following is true:
Most factoring companies have requirements to work with them, thankfully they’re quite simple. Below is a list of common requirements to work with factoring companies.
Factoring companies make money through factoring fees on each collected invoice. Each factoring company has a unique fee structure so the cost can vary from company to company. Some companies charge a one time fee based on the monthly volume of invoices and creditworthiness of clients. Other factoring companies charge additional fees for money transfers, collateral, and other operation costs.
Before signing an agreement, make sure the fee structure is clearly defined and you understand what the payment terms are. Not only will this help you predict future costs, but you’ll also ensure that you’re working with a reliable and consistent factoring company.
During the process of selecting a factoring company, there are several key points you’ll want to consider before moving forwards. These factors are listed below.
Factoring is a great financing solution for many businesses, especially startups, struggling businesses, and small companies. If invoice factoring seems like the right decision for you and your business, ensure that you understand the agreement before moving forward. Your cash flow will improve and you can work on growing your business through factoring.
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Loans Canada is pleased to announce it placed No. 131 on the 2022 Report on Business ranking of Canada’s Top Growing Companies.
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