By Carl Faulds
Invoice factoring and discounting are the perfect ways to tame a troublesome cash flow, by allowing you to borrow against the value of your invoices as soon as you issue them, and repayment being made when your customers pay you. It is the ultimate method of receiving funds immediately from invoices, rather than waiting 30, 40, or even 90 days before they are finally paid.
With factoring, the finance company assigns experienced credit control professionals to secure early payment, whilst with invoice discounting you retain control of your own debtor ledger.
But what are the biggest mistakes businesses make when taking out invoice financing?
1. Not reading the contract carefully
Your invoice factoring agreement is a binding contract, so make sure you read it carefully, and make certain that its terms exactly match the proposal you were offered.
You should also study the fine print for any additional fees and when these can be invoked, as well as consider any types of invoice that may be ineligible for borrowing. It is also important to understand the factor rate and any additional fees that may be included for early repayment or checking credit scores, for example. In general, a factor rate of 1-5% would be considered fair, depending on the monthly receivables, so be aware of higher charges.
2. Not sending invoices to your customers
This is incredibly basic, but you’d be surprised how many companies using factoring or invoice discounting fail to do this. Remember to send invoices to both the finance company and your customer, or there’ll be nothing to repay the borrowing.
3. Trying to get factoring on contracts
A contract is an agreement to deliver certain products or services for a certain price; an invoice is a bill for services delivered. Invoices can be used for factoring whilst contracts clearly cannot. Don’t repeatedly send your factoring companies contracts, as it’s likely to damage your working relationship. They should only be sent as supporting documentation if verification is required.
4. Not knowing the difference between invoice factoring and discounting
The difference between invoice factoring and discounting is that with discounting, your business will retain control of collecting the invoiced debt from customers. This can be beneficial in terms of retaining control and reputation by not including a middleman. However, at the end of the day you will be responsible for ensuring the lender is paid and chasing it through.
5. Failing to direct payments to the factoring company
As the name “invoice discounting” suggests, the finance company buys your invoices at a discount, then immediately advances the balance to you. This means that when your customers pay, the money goes to the finance company, not to you. Make sure your customers know who they’re supposed to be paying. Paying the wrong person can result in penalties for you, costing you dearly.
6. Ignoring the finance company’s minimum requirements
Some invoice finance companies are flexible about the amount and volume of invoices they will handle. Traditional factors, however, are not flexible and usually set a minimum volume to use their services. If sales are down and you find yourself issuing fewer invoices, of lower value, you may find the agreement terminated if you choose the wrong factor.
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7. Completing the application form incorrectly
Miss filling out sections of the form or supply the wrong information, and at best you’ll find your acceptance delayed—which can be catastrophic if you need financing fast. At worst, you’ll be turned down altogether.
8. Taking on unreliable customers
The great thing about invoice financing is you get paid immediately, which can smooth over cash flow problems from the occasional late payer. However, if you take on marginal quality business and a customer fails to pay at all, you’ll be in a bad position. You will already have received and spent the money, and will owe the finance company a pile of cash.
9. Using invoice factoring as your only means of business financing
Invoice financing is of course easier to access than many other forms of business financing, particularly for smaller businesses; however, it will generally end up costing you more. It is not always the best method for long-term finance needs and is more suited to securing quick financing to cover an immediate cash need. If your business has long-term financing needs for growth and expansion, then it would be wiser to investigate alternative financing methods, such as seeking small business loans.
Make sure you address these nine points carefully, and invoice factoring and discounting can be a great way to borrow—and give you the chance to say goodbye to cash flow problems.
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