In an ideal world, you would sell a product or service to an individual or other business and they would make the payment there and then. However, while individuals making purchases are typically required to make payment at the point of purchase, businesses are typically given 30- or 60-days credit before payment is due. Although this is normal, it can often cause cashflow problems for some businesses.
If cashflow is good, a business will simply wait until payment is due and will follow up with the business only if there is a delay. Nevertheless, if a business is struggling with its cashflow, it may need to find alternative solutions. One solution might be to try and get a loan. Then there are those companies that prefer to sell their outstanding invoices to a third-party financing company. This is known as factoring invoices. According to the experts at Thales Financial, invoice factoring can be the ideal short-term solution for some firms. But are there any downsides to the practice?
What are the Drawbacks of Factoring Invoices?
The biggest disadvantage of invoice factoring is in the contract that the small business enters. It is usually not a case of selling a couple of invoices and receiving 80%-90% of the money due with the factoring company keeping the difference when the invoice is paid. Most factoring companies require the business to enter a contract with terms that may lock said business in for a period of up to six months or longer. During this time, the business will need to continue factoring invoices, and they may have a monthly minimum amount that must be met.
Some factoring contracts have stipulations that limit how many invoices can be factored from a single customer, and they may not accept invoices for overseas customers. They will also require a guarantee from the business in the event that the invoice is not paid by the customer.
Factoring companies charge a fee for their service. These fees can vary from one company to the next, but they are usually a percentage of the invoice amount. You can expect a higher fee if your customer takes longer to pay the invoice. Depending on the contract, you might find that your rate increases every day that the invoice remains unpaid by the customer. Your contact could also include other fees that can add to the cost. For example, you might have to pay transaction fees when money is wired to you, or credit check fees for every check the factoring company runs on your customers.
Another big disadvantage of using a factoring company is in the impact that it can have on your customer relations. When you factor your invoices, you are effectively turning over control of collections to the factoring company. This can have a negative impact on some customers, particularly those that you have built a relationship with over many years.
The factoring company may have a completely different way of collecting payments than you do, and it might not sit well with some customers. If there are any issues between your customer and the factoring company, it could affect your business.
Conclusion
Businesses having problems with their cashflow might decide to factor their invoices as a quick solution. However, although this can be a way to generate money in a hurry, there are some drawbacks to invoice factoring, not least the fact that it may mean a lengthy contract with high fees. Furthermore, it could have a negative impact on your relationship with your customers. It is important to be aware of these issues before using this method to raise capital.
