If you’ve been looking for solutions to cash flow congestion for any length of time, you’ve probably heard a lot of opinions about factoring. Some of them were probably fairly strong, too. It’s a unique form of financing that is designed to provide a path to clearing invoices off your books, and the way it’s used is a huge part of the cost, so proponents of selling invoices to a factor tend to use very different strategies from borrowers who only rely on it occasionally because they prefer other tools. It’s also a financial resource that’s only available for your invoices, if your company uses a different accounting method, you need other tools. So how does it work? Strong opinions don’t usually lead to explanations, after all.
Mechanics of an Invoice Sale
Unlike accounts receivable financing, using a factor involves selling the invoice, so you’re transferring all the risk to the service in question. As a result, there is no second round of payment, but there’s also no recourse if the customer defaults. This makes factoring a little more expensive than AR financing in most cases, but the costs go down when you factor all your invoices at once and when they are fresh. Most business owners who view factors as an expensive final resort pay more than average because they hold invoices until they are old, then factor them. Repeatedly sending your invoices to the factor so none have a chance to age reduces the costs a lot. Once you and the factor settle on a percentage of the invoice pool’s total value, the cash is sent to you and your customers are notified that their financial obligations are now held by the factor.
Setting Up Regular Cash Flow
Sending out invoices every four to six weeks provides regular cash flow to your business while providing customers with a small window to make payment directly to your business, so not every invoice winds up being sent for factoring. The costs tend to be predictable when you have a regular relationship with a factor, so over time you can even work them into your estimates and rates. If you take this route instead of a one-time arrangement, the factor may have conditions to maintain the relationship, including the right to demand you stop doing business with customers who pay chronically late or who default.
Customer Communication Is Key
When you’re factoring for cash flow, it’s important you communicate to your customers that their debt is not delinquent and that the new payment destination is a matter of streamlining your own business. This helps make the adjustment easier and them at ease about the status of their relationships with your business. Regular clients will get used to the new rhythm of business quickly as long as they get clear messaging from you.