As with any type of funding for a small business, selling invoices is an option to consider. There are many different situations where this is the preferred option to a traditional bank loan or even opening a line of credit through the business.
Just like traditional funding through financial institutions, there are also potential issues to consider in choosing this option. Not all businesses should make the decision to move forward with selling invoices, just as all businesses will not benefit from a business loan or a line of credit.
Generating Capital
The purpose of selling invoices is to generate working capital for a business to address the gap in time between providing goods and services and collecting on the invoice. Depending on the terms of the invoice or contract, this could be 30, 60 or 90 days, which can leave a business without immediate cash but with income pending.
When a business needs to generate this short term funding selling invoices is worth considering. Since the business only needs to sell invoices equal to the amount of capital needed there is maximum flexibility and management over the process. To access this funding business will need to meet the minimum requirements for factoring based on the terms set forth by the factoring company.
Understanding the Cost
There is a fee assessed on the value of the accounts receivable by the factor. When selling invoices, it is important to understand what the rate will be as well any fees associated with the service.
Combined the rate and fees will be the cost to the business of selling invoices. It is essential the business calculate the amount of funding they receive after fees are deducted by the factor to determine if it is cost effective.
If a business has a sufficient margin in their product or service to cover the fees of the factor and still provide the working capital needed it is a highly effective option. It is also much less costly over the long run compared to a loan where interest will continue to add to the cost over the duration of the loan.
In some situations, the business owner or management group may not have a clear understanding of the actual gross and net margins on their products and services. In this situation working to determine those bottom line amounts is critical before selling invoices to avoid costly and potentially damaging miscalculations.
