The ultimate guide to better invoice factoring in 2022

The ultimate guide to better invoice factoring in 2022

Team Balance
Team Balance
May 24, 2022

Whether you’re a growing startup in need of cash flow or a large organization looking to streamline your payments processes without adding much-dreaded bureaucracy, invoice factoring can help you.

Below you’ll find the ultimate guide to better invoice factoring in 2022. Whether you’re a payments professional looking for better alternatives to traditional financing options or a newbie in desperate need of an “Invoice Factoring for Dummies Guide,” this article will cover everything you need to know from levels of risk to hidden fees. 

What is invoice factoring?

Invoice factoring as a practice actually dates back as far as ancient Mesopotamia, as documented by the Code of Hammurabi. Loyal, repeat customers expect manufacturers and wholesalers to extend them the trust they need to pay 30+ days after purchase once they’ve sold the goods. Invoice factoring is a system that allows businesses to sell their accounts receivable to a third-party provider. In turn, that provider advances some or all of the money upon delivery of the goods or services. 

B2B businesses often turn to invoice factoring because it’s better suited to their needs than a loan. Loans take months to approve, while invoice factoring contracts take a few days at most, and require significantly less risk, which is especially advantageous for young startups or any organizations that lack the physical collateral they would otherwise serve as a guarantee. 

While many companies do require a minimum commitment, invoice factoring is nonetheless conducted on an ad hoc basis. So, when the contract is over, the relationship ends. Also, while transaction fees can certainly add up over time, they’re far less formidable than paying back a large loan with high-interest rates to boot.

How does invoice factoring work?          

Invoice factoring, which is also known as accounts receivable factoring, is essentially a system of requesting credit either on a one-off or rolling basis. As a business, you’ll be selling your accounts receivable to a third party for a small fee. Typically, the invoice factoring company will forward you 70-90% of the transaction upon delivery, and when the customer pays, you’ll receive the remaining amount minus the financing fee.

There are two types of factoring: recourse and non-recourse. 

Recourse invoice factoring essentially means that you own some of the risk of delayed or defaulted payments. Essentially, it’s a loan. So, even if you’ve received an advance for a specific invoice, you’ll have to return that money later if your customers aren’t reliable. You’ll pay lower fees for recourse factoring, but in return, you’ll assume more risk as well.

Non-recourse invoice factoring means you own none of the risk. That is, it refers to a system wherein the company relinquishes its responsibility entirely for any invoices that aren’t paid. Businesses will have to pay more money in fees for this luxury, but in return, CEOs can relax knowing that they won’t be expecting a large expense. Of course, paying back the money for a single invoice is still easier than paying back an entire loan, but if you’re risk-averse, the additional coverage may prove worth it. 

How much does invoice factoring cost?

Factoring typically costs between 1-5% of the transaction depending on the level of risk and length of net terms involved. However, even the best invoice factoring companies often charge fees for closing, termination, recourse liabilities, and more.

Here are the main factors that can affect the cost of invoice factoring:

  1. Risk Underwriters will have to evaluate the risk of customers defaulting on payments. The higher this risk, the higher the cost. 
  2. Fixed Rates vs. Variable Rates Just like with interest rates for loans, invoice factoring companies can either charge fixed or variable rates. So, you might expect 2% of the invoiced amount per month with a fixed rate. A variable rate might start at 2% in the first month and increase or decrease month after month.
  3. Size and volume of transactions: Because the world of financing is based on percentages, the higher your transaction volume, the more room you have to negotiate lower rates.
  4. Advance Rates: Factoring companies will typically advance you a percentage of the total transaction when you submit the invoice and the rest when the customer pays. The higher the advance rate, the higher the fees.
  5. Fees to note
  • Sign-up fees: Be wary of any sign-up or application fees. Invoice factoring companies charge sign-up fees in order to offset onboarding costs, but they will often waive these fees for established, reliable companies. 
  • Contract termination fees: Many firms require a minimum commitment from any businesses they service because there are quite a few onboarding costs for them. If you find that you no longer need the service after a few months, you might be obligated to pay a termination fee for the inconvenience.
  • Credit check fees: Credit checks are an integral part of the factoring process, and many finance providers will roll those costs over to you. Whether they’re evaluating your company as a whole or your clients, invoice factoring companies might invest a great deal of time and resources into assessing risk. The more customers you have, the less likely they are to swallow those costs.
  • Late payment fees: Because invoice factoring companies assume the responsibility for collecting fees, they may charge you if your customers don’t pay by the due date. 
  • Service fees: Some companies charge an additional service fee to cover administrative work that goes into processing and managing payments. 
  • Collection fees: When you sign up for an invoice factoring service, you hand over the responsibility of collecting payments to a third party. They might try to charge you for the time and energy it requires to chase after your customers.
  • Payment fees: Since most invoices are worth tens of thousands if not hundreds of thousands of dollars in the B2B world, invoice factoring companies typically choose to send and receive payments using ACH or wire transfer to avoid paying credit card processing fees. However, they will usually ask you to cover these fees yourself.
  1. Industry: An invoice factoring company may judge you based on the industry in which you work. Whether these assumptions are justified or not, providers evaluate your risk at least partially by assessing payment standards within your industry at large.  For example, a wholesaler selling to large retail chains is far more likely to serve customers that pay promptly than a manufacturer selling machines to construction companies. Project managers in construction handle hundreds of sites at a time, and so they are notorious for chasing fires and delaying deadlines. Your company may be different, but without a previous relationship, invoice factoring companies will predict future performance based on current industry trends.
  1. Credit history: Even if you work in a risky industry, good credit history can go a long way. 
  1. Net terms: The more time you extend to your customers, the higher your rates will be. So, you’ll have to weigh the business you’ll gain by providing your customers with additional flexibility against the fees you’ll pay to the factoring company in doing so.
  1. Liabilities: If you do choose recourse factoring, you’ll have to return any advance you receive for invoices your customers never pay. That being said, non-recourse factoring has its limitations as well. While it may pay in cases of bankruptcy and insolvency, you should make sure to check a company’s policy carefully to see what vicissitudes they actually cover.

Invoice factoring vs. invoice financing:

Essentially, you should choose invoice financing if you want to take ownership–and assume the risk–for processing customer payments. If you want to sell that responsibility to a third party, then, you should opt for invoice factoring.

What is invoice financing though? 

Business invoice financing, which is also called accounts receivable financing or invoice discounting, looks very similar to invoice factoring except for one crucial difference. Technically, B2B financing is a lot more like taking out a series of small loans. You’ll use your invoices as collateral, but you won’t be selling off the invoices. While the end result is more or less identical, in the invoice financing process, they provide you the money you need to cover the transaction, but they place the responsibility on you to follow up with your own customers.

Is invoice financing a good idea? Is invoice financing risky?

Invoice financing is a good idea for businesses that need to streamline their accounts receivable and improve cash flow while maintaining control over their client relationships. 

If you’re concerned about a third party bothering your customers for late payments, then invoice financing could provide you with some peace of mind. Maintaining good customer relationships is really important for your brand and your bottom line. A negative experience with business invoice factoring company could drive away otherwise good business. 

On the other hand, invoice financing places the responsibility on you to follow up with customers. While you’ll receive the money for your transactions, you’ll also have to go through the trouble of reminding them of due dates.

So, if you’re working with established retailers like Walmart and Target, you probably don’t have any need to worry. However, if you have smaller mom-and-pop shops or lesser-known names purchasing from you on a regular basis, invoice financing may prove to be more trouble than it’s worth. In that case, invoice factoring may provide you with the cash you need without the headache of chasing unreliable customers.

How to choose an invoice financing company: 

There are countless options, but you should start with the following criteria in order to decide which are the best invoice financing companies for your business:

Selective/Spot invoicing vs. Whole sales ledger: You’ll want to decide whether you need a company to cover select invoices or your whole sales ledger. Depending on how a company assesses risk and what kind of minimum commitments they expect, they may require that you sell your entire sales ledger. While small and medium businesses may appreciate the convenience, larger enterprises may need more flexibility. 

Cost: Make sure to carefully review all associated costs before committing to any long-term contract, especially if you handle large transactions. The larger your transactions, the more room you have to negotiate lower invoice financing rates. After all, even 2.5% in fees can make a difference to your bottom line when you’re handling hundreds of thousands of dollars.

Branding: Adding a third party to your payment process might confuse your customers. If at all possible, you should choose a provider that allows you to whitelabel invoices and checkouts so that your customers will only see your color and logo. 

Credit Checks: Depending on how many customers you service, credit checks could significantly slow down your business, especially during the onboarding process. You probably won’t find invoice financing with no credit check, but the best providers will allow you to perform at least some credit checks automatically. Manual credit checks generally take at least a couple of days to process if not longer, and if you have dozens of customers, they may not be able to get you up and running within the time frame you need.

Technology: In a world mired in fax machines and paper invoices, you’ll want to look for a modern solution with an intuitive UX. An embedded payment processor can help you streamline your invoice financing without adding more overhead. After all, your provider should solve more problems for you than it creates. The last thing you’ll want to do after purchasing new technology is hire people to manage it. 

How online invoice factoring with Balance helps you scale efficiently:

Typically, invoice factoring requires some sort of sacrifice. Either, you choose non-recourse factoring and you pay higher fees for lower risk, or you choose recourse factoring and agree to partial advances and liabilities in case your customers refuse to pay in return for lower fees. 

With Balance, businesses don’t have to choose between cost and risk.

Balance, a payment processor designed to support B2B ecommerce stores, has built-in credit checks, so it can allow customers to undergo an instant KYC credit check right at checkout for any transactions below $50,000. This embedded feature allows Balance to both offer non-recourse factoring and charge as low as 2% per invoiced amount per month. Unlike traditional invoice factoring companies, Balance has the technology to verify the credit of each customer individually without having to run costly credit checks each time.

While any transaction over $50,000 with net terms requires a manual credit check, legacy customers need not undergo multiple checks. Therefore, even though large enterprises might have some initial startup costs when onboarding their customers, in the long term, the built-in invoice factoring system will still dramatically reduce overhead within accounts receivable.

As you can see, contrary to common belief, invoice factoring can prove invaluable both to small and large businesses. Invoice factoring is often synonymous with struggling startups desperate for cash flow, but that couldn’t be further from the truth. While invoice factoring is still invaluable to new businesses, with Balance’s all-in-one payments processing solutions, large manufacturers, wholesalers, and marketplaces can leverage invoice factoring to scale their revenue without adding more personnel.

Typically, established B2B enterprises that accept ACH, wire transfers, checks, and credit card payments with net terms also struggle to process payments effectively. Even with a large team of professionals within accounts receivable, processing B2B payments in 2022 is frustrating at best and chaotic at worse. If financial executives could rely on an embedded solution to handle that administrative work, then they could funnel the energy they spend staring at spreadsheets and chasing late payments into creative, meaningful solutions that really help push the company’s bottom line.

Why Balance is better than traditional invoice factoring or financing:

With Balance, you won’t have to decide between invoice factoring and invoice financing. Many companies choose invoice financing because it gives them a certain level of control over their customer relationships. However, Balance’s checkout and invoice system are completely white-labeled. Your customers never need to know that you’re working with a third party. They’ll see your colors and logo on our products, so the entire UX will look and feel like you.

While Balance is in charge of following up with customers who haven’t paid, we don’t charge late fees, and we don’t harass customers. Since we take the time, firstly, to ensure our clients have a dispute policy in place before onboarding and, secondly, to perform individual credit checks on all buyers, we feel secure in taking on any remaining risk. 

Plus, we get paid when you do. The better your business does, the more profit we make, so we have an invested interest in making sure you succeed. Therefore, you can rest assured that we treat your customers with the same respect and professionalism that you would.

Team Balance
Team Balance

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