When you are running your business, it’s not always the case that you will receive payment for your services up front. Sometimes you need to complete a service, provide a product, or finish a job before you can get paid for your work. And at times you may find that you need a little extra capital to complete the job so that you can get paid for your work. When that happens, that’s when invoice factoring steps in.
How does invoice factoring work?
Let’s use an example and say you are a landscaping company, and you’ve recently received a contract to do a $20,000 job. Before you get started, you know from your landscaping expertise that it’s going to cost you $15,000 to complete the job, but you don’t currently have the capital on hand to pay for the cost of the job. This is exactly where invoice factoring comes in. You can turn to an invoice factoring company to buy the invoice from you directly, though usually with a small discount.
So, to continue this landscaping example, you go to an invoice factoring company and they agree to buy your invoice for $20,000, minus a small fee (let’s say, as an example, 2%) for a total of $19,600. Then they give you the $15,000 you need within a few days. With that funding in hand, you go and complete your landscaping job.
Now for the final step. There are still a few thousand dollars missing from our imaginative invoice. So, with the job done, the customer will pay the invoice due, and the factoring company then sends to you the remaining balance of $4,600. Now your total received funds is $19,600, the total worth of the invoice minus the 2% fee from the factoring company.
Now that our analogy is over, there are a few things to consider about your personal business that will play a role in this process. Those things are: invoice amounts, your sales volume, and even how trustworthy your customer’s credit is. You can also choose if the factoring will be with “recourse” or if it will be “nonrecourse.” With recourse, what this means is that if your customer doesn’t pay the invoice, then you will be responsible to make up the difference to the factoring company. If it is nonrecourse, then you will not be held under any obligation if your customer fails to pay the invoice. All of these factors will be an integral part of deciding what your factoring fee will be.
Is this right for me?
While you may not like the loss of control on your invoices, you can get the funding to complete your job. You can experience better cash flow and the ability to get started on jobs immediately rather than waiting for another job to complete or waiting weeks for a more traditional loan to fund. Ultimately this is up to you to decide.