3 Types of Invoice Factoring for Small Businesses
Poor cash flow prevents businesses from reaching their maximum potential, or closes their doors off for good altogether. For small business owners, this could be a huge problem. As much as possible, business owners must secure a back-up funding to prop their business up during the hard times.
Invoice factoring could be one of the solutions that they can use. In this lending option, the factoring company buys a business’ outstanding invoices in exchange for cash that businesses, then, can put towards any business initiatives – marketing, expansion, operating costs, inventory, and more.
We’ll discuss into detail what invoice factoring is and tell you about the types of invoice factoring in this article. So, stick around.
What is Invoice Factoring?
Invoice factoring is a subset of invoice financing wherein the lenders “purchase” the invoices from business owners to give them a financial boost. Business owners give up full control over the lengers to the lenderes. It’s a viable financing solution for small business owners who are looking to gap cash flow gaps immediately. Instead of waiting for 30 to 90 days to get paid, merchants can advance the payments by working with an invoice factoring company.
It’s worth noting that since the business has already given up the control over the ledgers, they also release themselves from the responsibility of collecting customer payments. The factoring company – the one who bought the invoices – will be the ones to do it on the business’ behalf. In this case, the business’ relationship with the factoring company will be disclosed – a fact that small business owners would be uncomfortable with.
On the bright side, invoice factoring provides business owners with the cash they need to keep their business going and pursue opportunities. With more money on-hand, they can invest more, and therefore, gain more customers which then leads to business growth.
3 Types of Invoice Factoring
Business owners choosing invoice factoring as their main funding option must know that there are three types of invoice factoring. They should also understand that each of them works differently. Here are the three types of invoice factoring:
Recourse factoring is the most common type of invoice factoring that lenders and businesses use these days. In this arrangement, both the factoring company and the business being financed come to an agreement that the borrowing business takes full responsibility for theinvoices should customers fail to pay it within the allotted time. This puts most of the risk in the debtor, aka the small businesses.
In the event of non-payment of the invoices, the factoring company will give you three options:
With the risk inherently handed over to the business owners, it isn’t surprising why this type of factoring is relatively cheaper compared to non-recourse and spot factoring. So, if you’re looking for a cheaper way to get funding, recourse factoring would be a viable choice. However, you must ensure that your clients have an excellent payment history.
In non-recourse factoring, the lenders assume all the responsibility of the invoices. In other words, if the invoices remain unpaid, the factoring company shoulders all the losses. The risk stays with the lenders, not the small businesses. This is convenience is the reason why two-thirds of small businesses choose this type of invoice factoring.
Since the lenders are putting too much at stake in non-recourse factoring, borrowers can expect to pay higher fees associated with the funding. You’d also have to pay a higher fee if the factoring company sees that you’re selling invoices that are considered a higher credit risk(the invoices’ owners don’t have a flawless credit background).
It’s also worth noting that given the risk the lenders assume in this arrangement, finding a lender that offers non-recourse factoring would be a challenge. If you do find a company that offers this type of financing option, there are usually a lot of stipulations for the agreement. For instance, they would have to check if your customers are credible and perform financial background checks. Before going all in, be sure to understand the fine print of your contract first.
Spot factoring, also known as single invoice factoring, is a type of invoice factoring wherein the business only sells a single invoice to the factoring company. The invoices being sold are usually worth thousands of dollars. This makes it a perfect solution for businesses who are in a cash pinch but need a large sum to put towards specific business needs (business opportunity, expansion, etc.) or to address financial emergencies. Factoring companies typically don’t expect any repeat business in this arrangement.
The cost of spot factoring could also be higher compared to its counterparts. Small business owners typically pay higher fees for the convenience and control that spot factoring offers.
The Bottom Line: Which Type of Invoice Factoring is Right for You?
Companies experiencing cash flow issues can turn invoice financing to give their working capital a boost. The choice of what type of invoice factoring is right for your business boils down to your current situation and needs.
For instance, recourse factoring would be viable choice if you’re looking for a cheaper way to get cash in exchange for your invoices. On the other hand, if the price for the financing isn’t an issue for you and you want to be free of the responsibility of the invoices, non-recourse factoring would be the ideal choice for you. Moreover, if you’re in need of an immediate access to cash for additional working capital and you have a single invoice worth thousands of dollars, spot factoring would be the best choice.
Invoice factoring offers a lot of benefits for businesses. However, the only way you can take advantage of those benefits is by studying the different types of financing available. Do your research, determine your business needs, and identify the benefits each type of factoring offers. It’s the only way you can choose what financing option best suits your company’s current needs.