What to Consider When Picking a Factoring Company
What is invoice factoring, and how can it help to secure a business's cash flow?
Invoice factoring companies offer significant assistance to businesses that handle a large volume of outstanding invoices. These entities help ensure continuous cash flow, thereby making the business more easily sustainable. They do this by taking care of the debt collection function for you. They get direct payments from your customers and forward the money to your account after deducting their fees.
Not all factoring companies can respond effectively to your business’s unique needs, however. In this article, we present the factors that you should look into before you pick the factoring company that you are going to partner with.
Almost every factoring agreement has provisions regarding the float period. The float period is the amount of time that you have to wait before a customer’s payment gets posted on your account. Usually, float periods last up to the three days since the payment is made.
The waiting is going to be an issue if it is stipulated in your contract that the factoring fee increases as the outstanding invoice ages. We shall talk more about this when we discuss pricing below.
To illustrate, suppose the contract states that the factoring company can charge 1.5% of the invoice amount for invoices that had been outstanding for 16 to 30 days, and 2.5% for invoices that are 31 to 45 days old. A payment that has been made on the 29th day will only be posted on the 31st day, which puts that particular invoice in a more expensive bracket. This can lead to a significant increase in your financing expenses.
If possible, negotiate with the factoring company to reduce their float period. If you can find one, it will be much better to deal with a company that does not make you wait before they post payments that they received.
Generally, the price of a factoring service depends on three major factors: the total amount of the invoices, how long the invoices have been outstanding, and the credit quality of the customers. As much as possible, avoid companies that have lots of ancillary fees.
Economies of scale still work in factoring deals. Since many of the expenses associated with the maintenance of the factoring relationship are somewhat fixed, you get more value for money as the invoice value gets bigger and bigger.
The age (in days) of the outstanding invoices matters because this is also the length of time that the factoring company’s money is out. Clearly, the risk of an outstanding invoice not being paid rises with time.
Finally, the credit quality of the customers matter because this represents the likelihood of the money being returned. If your company’s customers have generally bad credit ratings, then you should be ready to pay more to compensate for the risk that the factoring company is going to take.
Factoring relationships clearly involve money, and things can easily go wrong when money is at stake. Due to this, it’s important that you choose a factoring company that is represented by people who are approachable and easy to talk to, making it easier for you to communicate and make requests whenever necessary.
Choosing the right factoring company isn’t overly difficult, but it’s still something that you need to do systematically. Presented here are just three generally more important aspects. There might be others that are unique to your niche or industry.