Invoice Factoring: Smart Financing or Risky Business?

Invoice "factoring" can get you paid fast, but it also poses special risks. Here's what you need to know to keep from getting burned when selling your unpaid invoices.

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The Factoring Agreement: How To Get The Best Deal
Factoring transactions are governed by contracts, or factoring agreements. You can choose to "factor," or sell, a batch of invoices, an entire customer account, or several smaller invoices over the course of business with a factoring company.

Keep in mind that the rates you're charged (the factoring company's "cut" of the transaction) are determined not only by the creditworthiness of the clients, but also by the total invoice amount and payment due date. Factoring companies use their own formulas to determine rates, advance amounts, and approvals, which can vary from company to company.

These four things can impact the total cost of your transaction:

  1. Amount of Invoices: The higher the dollar amount of individual invoices, the better deal you're likelier to get. While you may not be able to negotiate on rates based on dollar amount alone, you will qualify for a significantly higher advance amount if you're able to assign invoices for $10,000 or more.
  2. Number of Invoices: Factoring services prefer to take on a few high-dollar invoices, as opposed to customer accounts with several small amount bills. Generally, the less labor-intensive the collection process, the better deal you'll get.
  3. Billing Method: Companies that use non-cumulative billing (for example, bills are sent for services already delivered) will be able to obtain better rates. Cumulative billing often requires ongoing interaction with the client (adding to the "tab" or open bill, etc.) and is more time consuming -- and less desirable -- for the factoring company.
  4. Recourse Factoring: Recourse factoring, where your business "guarantees" a customer invoice (you return the advance amount if a customer doesn't pay by the due date), is less risky for the factoring company, so it's less expensive in the short run. However, it is more risky for you -- it could end up being more costly overall if the customer doesn't pay as expected. You could even find your company is responsible for fees and penalties along with the repayment of the advance.

Before You Sign On The Dotted Line
In many ways, factoring is just like any other type of business financing -- you should choose the company that offers you the best rates, explains everything thoroughly, and provides great customer service. With so many factoring providers looking for business, it pays to shop around for competitive rates and compare specific contract terms before making your decision.

In particular, if your contract contains recourse provisions, requires you to pledge collateral, or specifies other penalties or costs in the event that the customer does not repay the factor, be sure to consider these potential costs as part of the "risk level" of the arrangement.

Though factoring can allow you to reap the benefits of a faster payment cycle, it also poses special risks. You're turning over your collections to a third party, and that could affect your reputation and your business relationships. Make sure you're absolutely confident the factor will treat yourr customers with respect, and make sure to read any and all contracts carefully -- or have your attorney read them -- before signing on the dotted line.

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Resource Nation provides how-to purchasing guides, tips for selecting business service providers, and a free quote-comparison service that allows business owners to compare price and service offerings in over 100 categories from invoice factoring to business cash advances.

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