One of the biggest concerns small and medium sized businesses face today is cash flow problems. Financial institutions aren't always willing to hand out loans to companies that are already short on funds. If you share this struggle, you may have wondered about spot factoring (also known as invoice financing or invoice factoring). For an alternative to factoring, try Net terms-as-a-service options like Resolve.
Spot factor companies, also known as “factors”, purchase a business’ accounts receivable invoices at a discount and pay out an advance to your account soon after. There is no initial fee as they understand that you need all the working capital you can obtain, but fees are built into each agreement.
The spot factoring process can be part of meeting a small business' needs for working capital. Your company would complete an order and send the invoice to your customer. Once fulfilled, a copy of the invoice would be sent to the factoring company.
The invoice factoring company will review and verify the invoice and complete a credit check on the company you've invoiced. On approval, a portion of the invoice (typically 70-90%) is advanced to the business and the balance is held. Once your customer pays on their invoice, the factor will release the remainder of the funds after taking their fee.
Spot factoring is also known as single invoice factoring. Rather than ask a factoring company to approve a large number of invoices, you are only asking for factoring services on a single invoice. This is more common if the invoice amount is large and/or is from a new customer that hasn't established a strong payment history with you yet.
Spot factoring can be a good alternative if your business doesn't qualify for a traditional bank loan or if time is an issue. The approval process for business finance or a business loan is extensive, and most young businesses and startups won't have success. Of course, this doesn't stop the need to access funds and continue to keep good relationships with suppliers and staff.
Factors are often more lenient than typical lenders, and this is one of the advantages of spot factoring. However, they can also be more conservative in their lending. One advantage of working with a factor company is they tend to process applications quickly. This makes sense when you consider that their primary market is businesses with cash flow problems and that advance rate is important.
There is another option for business owners to consider: Net terms-as-a-service. Companies that offer these digital net terms services work with businesses to conduct discreet credit checks. This gives insight into both the risks in extending credit and appropriate credit limits and net terms for each customer, all based on their financial creditworthiness and payment history.
Resolve is a highly-rated company offering these services. In addition to net terms and credit management solutions, they also pay out up to 90% of each approved invoice value within one business day—as close to an upfront payment as you can get. This eliminates the need for companies to either act as banks extending loans in the form of credit to their customers or to pay high spot factoring fees.
Alternative solutions avoid the issues factoring can bring to your business: Lasting damage to your customer relationships and your business reputation. Net terms-as-a-service is actually designed to improve your customer’s experience with your business, from faster credit checks, to sleek online payments portal, and professional reminder emails.
Many sites report high annual percentage rates (APR) with factoring companies. Often these APR’s in factoring arrangements can be upwards of 15 – 78%. But it’s important to remember that an APR is not an accurate appraisal as a factor's fee is based on a specific transaction, not interest on a long-term loan. It's highly unlikely that a factor would charge your business their 30-day rate for a whole year while you attempt to chase down a slow-paying client over one invoice.
More realistic scenarios are that you would be charged the factor's rate based on the client's 30-, 60-, or 90-day payment terms; or, if the client pays late, there are additional fees (typically 1 percent for every 10 days an unpaid invoice is late).
Outstanding invoices and late payments are important issues to consider with spot factoring. If your client completely fails to pay the invoice, most factoring agreements require that your business reimburse the cost of the invoice. This is very likely with spot factoring work.
The only exceptions may be working with a company that offers digital net terms, or choosing non-recourse factoring. With non-recourse factoring, you tend to pay higher fees in exchange for not being held accountable if the invoice isn't paid. Even this option is not fail-safe, and every factoring contract needs to be reviewed carefully to determine any exceptions.
Factoring companies may offer a free quote, or discount rates for specific circumstances. It's possible to use spot factoring as a short-term financing option to access nearly immediate cash on individual invoices.
The application process to be approved for spot factoring tends to be very straightforward and has less paperwork and requirements than a traditional bank loan.
Some common requirements for factoring companies include:
- Proof of ownership (often an LLC).
- Minimum length of business operation. You may be required to have been in business for a minimum amount of time.
- You are a B2B business that doesn’t get paid at the time of sale (different than B2C companies that get paid upfront like retail or service)
- Your client has a respectable credit score.
- Spot factoring is most likely considered for large invoices
- No liens or holds on your invoices. Past declarations of bankruptcy will also disqualify you from entering an invoice factoring agreement.
If you're considering a factoring facility and want to use spot factoring, be sure to do your research before agreeing to any terms with a company. While many factoring companies are reputable, the nature of the transaction can also be a potential target for unscrupulous companies.
Always read contracts carefully and go through online reviews of the company. Every company is different, and it’s well worth the research time to find the one that’s right for you.