One of the great ironies of running a business is that you can have great revenue figures, but still feel pinched on the cash flow side of things.
That’s because revenue doesn’t always equal free flowing cash – at least not immediately.
In many industries and business models, it can take weeks or months for invoices to be sent, paid, and cleared into usable cash for the business.
It’s not uncommon for businesses to have five, six, or even seven figures worth of revenue tied up in invoices.
But what happens when you need this cash now? Is there a better option than patiently waiting for clients to settle up?
Yes, there are answers.
And depending on circumstances specific to your business, invoice factoring – also known as factoring – could be the perfect solution.
Invoice factoring is a specific financing method in which business owners are able to quickly unlock revenue from pending invoices to be used for things like operational expenses and other growth activities. You can think of it like getting an advance on your pending invoices.
Invoice factoring works by selling your accounts receivable to an invoice factoring company in exchange for cash. This means the invoice factoring company pays you and the factoring company is then paid later directly by your customer. It’s a way of liquidating accounts receivable so that you don’t have to wait 90 days or more for a customer to pay.
Every invoice factoring company has slight nuances, but they generally pay in two installments:
Invoice factoring companies work very similarly to debt collection agencies. When a credit card company needs to be paid faster, they’ll sell the debt to an agency. The agency pays the credit card company a percentage of the balance due and then becomes the one that the money is owed to. (It’s not a perfect example – especially when you consider debt collection agencies often pay pennies on the dollar – but it’s the same basic concept.)
Invoice factoring isn’t necessary for most businesses. However, there are certain industries and business models where it makes a lot of sense. Generally speaking, it’s a good fit for B2B companies where payment terms are between 30 to 120 days. You’ll also find it most useful if your business operates on a “final sale” basis, rather than a consignment or contingency basis.
The following industries are good candidates for invoice factoring:
This doesn’t mean your business can’t use invoice factoring if you aren’t on this list. We’re just giving you an idea of the types of companies that most commonly use it. If you think you could be a good candidate, certainly look into it.
Invoice factoring is an attractive option for several reasons. Let’s explore some of the biggest advantages that businesses enjoy when factoring:
As wonderful as invoice factoring can be, it’s not a perfect solution. (To be honest, there is no perfect solution other than having your clients quickly pay you in full.) Here are some of the negatives associated with invoice factoring:
The decision over whether or not to use invoice factoring usually comes down to one simple question: Are you willing to give up 9 percent of an invoice (for example) in order to access 91 percent of the invoice right away?
If you believe that having faster access to a smaller amount is more valuable than accessing the full amount in several weeks or months, then factoring is a good fit for your business.
Are you looking to exit your business? At InvestNet, we’re always searching for private company investment opportunities throughout the middle-market. Ideally, we’re in search of profitable companies in growing markets. If you think you fit that bill, please reach out!