Government Contracts Invoice factoring is a financial transaction in which a small business sells its unpaid invoices to a third party in exchange for immediate cash. Liquidity crunches are implicated in the failure of approximately 82 percent of all small businesses: A small business may look good on paper with a healthy balance between accounts receivable, operating expenses and other outstanding debts, but if that business can’t wrest timely payment from its clients, then it may face a cash flow crisis that could easily pull it under when it’s time to meet payroll, pay rent, purchase raw materials and perform other vital operational functions. Invoice factoring is a solution that can prevent this from happening.
Government Contracts Invoice Factoring Advantages
Government Contracts Invoice factoring is a viable alternative with many advantages for small businesses that don’t want to increase their debt load.
• Speed of transaction: Once your business is approved by your factoring agent, invoice factoring is a quick transaction. Small businesses that take advantage of it typically see funds within 24 to 48 hours.
• Your business doesn’t need a great credit history: When determining your eligibility, factoring agents assess the potential creditworthiness of your customer base more than they consider your business’s credit history.
• No additional loans to pay off: Invoice factoring is not a loan, so it’s not going to throw your business’s ledger book out of balance by increasing the accounts payable entries.
• Eliminates customer lag: Unfortunately, many customers don’t remit payments in a timely fashion. Many of these customers may be regular customers whose business you don’t want to lose. Invoice factoring gives you a way to monetize these late payments.
How Does Invoice Factoring Work?
Once your invoice factoring agreement is in place, you will bill your client for the goods or services you’ve provided the same way that you always have. Instead of forwarding your invoice to that client, however, you will forward it to your factoring agent. The factoring agent will then take over all future communications with that client regarding that invoice.
In exchange, the factoring agent will deposit a percentage of the invoice’s face value in your business bank account within one to two business days. The exact amount will differ from factoring agent to factoring agent but is typically above 70 percent of the total amount of the invoice.
After the client pays the invoice, the factoring agent will deposit the remaining value of the invoice in your account less the fees that you have agreed to pay the agent.
How Does Invoice Factoring Compare to a Loan or a Line of Credit?
Two forms of financing that are popular with small businesses are loans and revolving lines of credit. Bank loans advance money to small businesses within a fixed repayment schedule. Revolving lines of credit are analogous to personal credit cards in that the business borrows money from the bank up to a predetermined amount and regains access to these funds as the borrowed amount is paid down.
Both these financing solutions require the borrower to have a good to excellent credit rating, which many small businesses—particularly those that are just starting out—do not have. In addition, there is a limit to how much a bank will advance your business. With invoice factoring, you have access to practically the entire amount of revenue your business is capable of generating.
What’s In a Government Contract Invoice Factoring Agreement?
Setting up an Invoice factoring agreement is a relatively simple process. If the primary customers for your goods and services are other businesses, chances are that you will be eligible for this service. Most factoring agents will require a contractual obligation. The terms of the contract will include:
• Commitment length: Contracts can be set up for as short a period as three months or for as long a period as several years. Some factoring agents will even be willing to individualize the length of the contract for your business’s specific needs.
• Invoice volume: You will probably have to meet a minimum monthly number of invoices. By committing to this monthly minimum, you will be able to lock in higher advances and lower fees.
• Advance rate: The amount of the invoice’s face value that you will be advanced depends upon your minimum monthly invoice volume as well as general pay trends and how highly your factoring agent rates your customers’ creditworthiness. Advance rates are typically 70 percent or higher.
• Factoring fees: Factoring fees, which are also known as discount rates, vary between 1 and 6 percent per month and can be accrued daily, weekly or monthly. Simply put: The longer it takes your client to pay you, the more your factoring agent is going to charge you in fees.
While some factoring agents contract with small businesses in a variety of sectors, other factoring agents specialize by industry. The former are known as factoring generalists while the latter are factoring specialists.
Another critical distinction that you should keep in mind—because it will have an effect on your bottom line—is the difference between recourse and nonrecourse factoring agents. Recourse agents retain the right to sell your invoice back to you if your client reneges on the payment. The time frame involved in this transaction is usually 90 days. Recourse agents are the norm in the factoring industry.
Nonrecourse agents, on the other hand, assume the full credit risk for deadbeat clients. Because they are assuming that risk, the fees they charge are generally higher and the credit reviews they perform before they agree to work with you far more stringent.