One of the major setbacks that small businesses face is lack of funding. Where often cash flow is further strained by unpaid invoices. With the strict procedures and long application process for a bank loan, most SME’s are left looking for alternatives. Invoice factoring is an alternative form of small business finance when mainstream options may not be available.
While it is not a loan per say, it is the best way for small businesses to secure funds. Invoice factoring is where a business owner sells his unpaid invoices to a third party, usually a factoring company, at a discount, in exchange for a tidy sum of money. A discount rate is charged based on various factors like the sales volume, invoice amount and the customer’s credit worthiness ad deducted from the amount payable. The factoring company usually get their money back when all the invoices are paid up.
There are 2 common types of invoice factoring:
Recourse factoring: This is where the small business only sells the invoices to a factor. Should the debtors fail to pay uncollected invoices; the business will have to buy them back.
Non-recourse factoring: For this type of factoring, the lender assumes all liability for the uncollected invoices. This is the most preferred by small business owners.
Some main features of invoice factoring include a short period of between 3 to 6 months, discount rates and due diligence by the lender to determine creditworthiness.
Benefits of factoring for small businesses
Some of the reasons why invoice factoring is very popular among business owners include. Improved cash flow- through this mode of financing, small businesses manages to retain their loyal customers and still get funds. This helps in growing the business.
High rates of approval- unlike other sources of financing, invoice factoring does not have strict qualifications. This makes it the best options for small business owners with bad credit or a business with limited credit history. The only thing the factoring company looks at are related to the invoices.
There are no collateral required, invoice factoring is a type of unsecured financing. This means that small business don’t have to put out their assets as collateral. It also provides immediate capital that can be used to cover funding gaps and meet short term business obligations.
Small businesses, especially start-ups, rarely have a credit history or assets to put up as collateral. This rules out most methods of financing like traditional bank loans. Despite being a bit expensive, invoice factoring remains to be one of the best ways to finance a small business.