Pros and cons of invoice factoring

If your business is growing rapidly – and there are plenty of businesses achieving that no matter what you read in the media right now – then you may find yourself in a unique financial situation. That's when you are selling so much that you can't get the money in the door fast enough to pay for the next batch of products. It's a common problem, especially for businesses that issue invoices on 30 day terms and find some clients prefer to extend their terms to 45, 60 days or longer. Without the cash in the bank from previous sales, where are you going to find the money to pay for future supplies? There are a number of options around the problem including borrowing money with a business loan or overdraft to create more working capital. A less risky way of borrowing could be to use something called invoice factoring also called invoice financing or debtor finance.

Invoice financing is when you effectively borrow money secured against invoices you have issued. You would essentially send a copy of every invoice issued to your factoring company. It will then "lend" you a percentage of that invoice and collect payment due itself. The balance due is then paid to you.

Invoice factoring has been around for thousands of years, with some historians tracing it back to the Roman Empire and further. But it isn't for every business. We recommend that you speak to an Intellichoice mortgage consultant first to check whether this is suitable for your business. We may be able to suggest alternative financial solutions to help fund your business growth.

We examine the main pros and cons of invoice factoring.

Factoring as your friend

• Positive cash flow: There can surely be no smarter way of keeping a positive cash flow than factoring. The perfect world where customers pay immediately doesn't exist so this is the next best thing. The money is in your bank account much faster, making it less likely for your business to run out of cash while it grows.

• Get cash fast: If your business has a number of outstanding invoices, a factoring company may be able to pay a high percentage of them to you quickly.

• Better financial planning: Because you know exactly when the money will hit your account, you can take much more calculated financial risks. You may also find it easier to attract investors and borrow capital as you can prove a regular cash flow.

• Have more knowledge about your customers: Many invoice factoring companies insist on credit checking your customers before you offer them credit. This reduces risk for everyone. There's no point selling something to a customer who doesn't have the means to pay.

• Highly competitive industry: There are a lot of players in the industry, which is great for keeping prices low.

• Makes you look more professional: Some customers may respect a factoring company more than you, meaning they may pay more quickly.

• Avoid bad debts: If you enter into something called "non-recourse factoring", the factoring company is responsible for the debt if it turns bad. Of course this works out more expensive than "recourse factoring" where any debt problem is still yours.

Factoring as your foe

• Cost of borrowing: Invoice factoring is still a form of borrowing and there's a cost associated with that. You may have to pay a fee for every invoice factored, plus interest on the money you have "borrowed". So slow-paying clients will still cost your business money.

• You are still liable for bad debts: With "recourse factoring" the debt problem is still yours. So you will still lose money on clients that don't pay. Factoring companies will ask for their advance on the invoice to be returned, often within a fixed period of time. And of course they may take the money from future advances, which will affect your cash flow.

To find out if invoice factoring is ideal for your company, speak to the mortgage brokers at Intellichoice first on 1300 55 10 45. We may be able to recommend other cash flow solutions that suit your business needs better.