The Terms and Conditions to Know Before Factoring
Invoice factoring is common way in which businesses obtain funding to increase cash flow. Often times the financing is used to supply larger orders, increase inventory, or hire more staff to keep up with business growth.
While factoring is a simple and legitimate way to help cover some business expenses, it’s important to know all the terms and conditions that go along with this type of financing tool.
How it Works
In the simplest terms, invoice factoring is just selling outstanding invoices to a factor company to get upfront cash for your business. The factor company with pay you for the invoices, at a discounted rate, collecting the balance when the invoice comes due. Generally, the discount rate can be anywhere from 1 percent to 6 percent, depending on the creditworthiness of your customer. This fee can accrue monthly, weekly or even daily depending on the terms of your agreement.
Recourse vs. Non-Recourse Factoring
There are only two types of factoring – recourse and non-recourse. Recourse factoring the most common. With recourse factoring, if your customer fails to pay, you are responsible for covering the invoice. With non-recourse factoring, should your customer default, the factor company covers the unpaid invoice. While this may sound like the better deal, non-recourse factoring comes with higher fees and a steeper discount rate than recourse factoring.
The Fine Print
Now that you understand the basics of how invoice factoring works, and the two types available, don’t forget to pay attention to the fine print of any invoice factoring agreement. Most factor companies include extra fees such as a maintenance fee, or a lockbox fee on top of the application fee. You’ll also want to see what the penalties are for early termination or cancelation of the agreement.
Aside from added fees, all invoice factoring agreements come with their own terms and conditions. This includes the length of the contract, if you must sell a minimum or maximum number of invoices and which types of invoices you can sell. Invoices are usually required to be from customers the factor company has approved.
Lastly, you’ll want to pay attention to whether your agreement is notification or non-notification. With the first, your customer will know that their invoices have been sold, while the latter is a more discreet option.
When small businesses need to find extra money to increase immediate cash flow, many will turn to invoice factoring. This type of financial tool can be a great asset as long as you understand how it works and are aware of all the terms and conditions associated with factoring.