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One of the biggest challenges that the owners of small and mid size businesses have is waiting 30 to 60 days to get paid on their invoices. Although large businesses can usually afford to wait, smaller businesses usually can't. As a matter of fact, waiting to get paid on their invoices, usually affects the owners ability to meet payroll or pay the company's bills. This problem can even be more frustrating if the business has a number of orders that it cannot fulfill because its cash is tied in unpaid invoices.
How can invoice factoring help you?
Invoice factoring, also known as accounts receivable factoring, is a financial tool that allows small business owners to capitalize on the power of their slow paying invoices. It allows you to turn your invoices into immediate cash, enabling you to fund your business operations. Although it is not a well-known fact, invoices from strong credit worthy commercial clients are excellent collateral, especially for factors. Although most banks won't take it - invoice factoring companies are more than willing to provide you with financing based on them. This makes factoring an ideal financing vehicle for small and mid size companies, as well as knowledge-based businesses and employee intensive businesses.
How does invoice factoring work?
As opposed to most banks than lend you money against collateral, invoice factoring companies buy your invoices outright. The factoring company buys your invoices and provides you with funds immediately, while they wait to get paid by your customers. Let me describe the transaction with an example:
1. Let's say that you sell services to Company A and Company B. As soon as you provide them with services, you issue invoices.
2. At the same time, you send copies of the invoices to the factoring company, who buys them and provides you with an advance payment for them.
3. The factoring company waits to get paid by your customers. Once paid, any remaining funds, are sent back to your company.
The invoice factoring process can be repeated for every invoice that you issue, providing you with a flexible line of financing that grows with your business.
How much will an invoice factor advance my business?
The factoring transaction is commonly done as a two-installment sale. The first installment is called the advance and is paid to you as soon as you submit the invoices. Advances can range anywhere from 60% on the low end up to 90% of the gross value of the invoices. The average advance is about 75% (for the industry) The remaining installment, called the rebate, is remitted to you once the invoices are paid.
The cost of invoice factoring
The actual cost of an invoice factoring tramsaction is determined by three criteria. First, the credit worthiness of your customers. Second, the length of time your invoices take to get paid. Third, the monthly factored volume. Your cost, actually called a discount in the industry, can be as low as 1.5% or as high as 12%, per transaction.
How can I determine if invoice factoring will help me?
Generally speaking, invoice factoring will help you if you have a business that has reasonable profit margins or is growing quickly. Mid size companies with 20% or more of profit margins or large companies with 15% profit margins can usually do well with accounts receivable factoring.
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