Cashflow is the lifeblood of business, and invoice factoring can be a useful financial tool to help small- and medium-sized businesses improve the management of their receivables to help grow their business. We invite you to use the following information as a guide to help you to better understand how to get a business cash advance against your AR’s, tips on what to look for in a factoring provider and how to avoid common invoice factoring tricks and tips.
This article will explore the following:
- Why Do Companies Factor Receivables?
- How Factoring Companies Work
- How Invoice Factoring Companies Make Money
- Common Invoice Factoring Tricks and Tips
- Ways to Avoid Invoice Factoring Tricks
- 12 Tips to Protect Your Business from Factoring Tricks
Invoice factoring allows you, as a business, to get the money you’re owed into your bank account faster, adding a level of predictability to your cashflow so you can better manage your business.
Why do it: By partnering with a factoring company (sometimes referred to as a “factor”), you can get the money owed to you in your receivables in advance of when you would normally collect it. This can help remove a lot of the headaches around how you manage your financials, allowing you to stay current on payroll and IRS tax obligations, make payments to vendors on time, and concentrate on running your business, rather than chasing down receivables.
How it helps: Factoring invoices can also allow a company to take on new business that it may not otherwise be able to handle financially. Many times, companies do not have the financial strength to fund the startup, payroll and other expenses related to a new contract or piece of business and then wait 30, 60 or 90 days to get paid. The profits might be there, but the startup cash needed – to get to the profits associated with the new business – is not. That is where factoring comes into the picture. You do not have to wait for your accounts receivables to fund growth. You can use your existing business to fund your growth with factoring.
Factoring example: Janitorial and contract cleaning companies often are forced to turn down business – and opportunities for additional growth – because they lack the cashflow to cover any increases to their week-to-week business expenses, plus owners are often hesitant to take on additional debt. To grow the business, they need to add more cleaning staff, purchase more cleaning equipment and supplies, and have enough money to fund a larger payroll – all this before the new customer pays their first invoice. Invoice factoring can be a valuable financial tool to support small business growth, instead of adding additional debt.
Obviously, most business tools come with a price – a value exchange for access to services provided. Even QuickBooks and Microsoft Office cost your business money to use. Invoice factoring is no exception. So before we get into some to the invoice factoring tricks and tips to watch out for, let’s first look at how invoice factoring companies make money.
Types of fees: Invoice factoring companies make money in fees, and those fees are based events. There are two types of events that you need to be aware of: visible events which create “visible fees,” and hidden events which create “hidden fees.” The primary visible events are the payments from your customers and these visible fees are based upon on how quickly the invoices used to support the factoring are paid by your customers; these hidden events are somewhat more difficult to identify, but the hidden fees that they create can very expensive for your business.
In the next section, we will dig into examples of how some invoice factoring companies use their visible fees – in addition to hidden fees or unexpected additional fees – to make money. But before we do that, let’s look at how factoring companies work.
What qualifies: Before we dig deeper, it is important to remember a few rules of the road:
- You can only factor accounts receivable for work that has been completed.
- You must be able to provide evidence that backs up and substantiates that completion.
- Your customer must be creditworthy.
How factoring works: To illustrate how factoring companies work, let’s say you decide to factor a $20,000 invoiced receivable. (Please note that the numbers, advance rates and financing fees used here are samples used for educational purposes. Actual rates and fees will vary.)
The example $20,000 factoring transaction breaks down as follows:
- Receivable amount: $20,000 (This is the amount of money invoiced, which is slowing down cash flow as the client company is waiting for payment.)
- 85% advance available: $17,000 (This is the amount of money the client company can have advanced to them based on the invoiced receivable owed, minus the financing fee.)
- 15% held in escrow: $3,000 (This is the amount the factor company and the client company hold in a separate account as a cushion against future fees or payment delays)
- Total advance paid to your company: $17,000 (This is the amount paid for use right away.)
- If the invoice is paid on time (for example, in 30 days), the money that was held in escrow ($3,000) less factoring fees (-$500) for a total of $2,500 is paid out to you . If the invoice is not paid on time, additional agreed-upon fees may be deducted from the escrow account.
AR Factoring Advice
Don’t commit to an invoice factoring company unless they’re upfront about the fine print.
As an example of extra fees, let’s say the invoice is paid AFTER its 30-day due date. If the invoice is paid after 30 days, half of the original financing fee (an additional $250) is charged for each 15-day period, or part thereof, that the invoice remains outstanding. So, in this example above, another $250 would be charged if the invoice were paid after 45 days. These additional fees would be applied to the funds held in escrow.
This is a basic example of how factoring companies make money. Let’s explore further.
Like most industries, invoice factoring is made up of responsible, ethical businesses – people who focus on the best interests of their clients. But unfortunately, there are some less reputable firms that engage in factoring tricks and sneaky business practices, thereby taking advantage of their clients – businesses that need every dime available to them to fuel their growth. With so many factoring options available – and so many good ones – it can be difficult to recognize the best from the rest.
With 20-plus years in the invoice factoring business, allow me to share a few of the invoice factoring tricks that some factoring companies use, plus tips to make sure you protect your interests and to help ensure that your factoring partner delivers as promised.
AR Factoring Advice
Make sure all of these terms are acceptable, standard, clearly defined and explained to your satisfaction before you enter into a factoring arrangement.
One of the Most Popular Invoice Factoring Tricks:
Sitting on Payments to Drive Up Fees
As mentioned earlier, a fee may be triggered when a payment owed comes in late. But who is to say when the money arrives and when it posts against your account? Historically, prior to 9/11, banks could take anywhere from one to seven days to clear checks and factors would add clearance days to payments to cover the “float” between the time a deposit was made and when the deposited funds became “good” funds. Since that horrible day, technology in the form of Check 21 has eliminated the float and most checks are considered “good” funds the next day. However, the practice of “clearance days” for waiting on payments to clear has become a common invoice factoring trick. This obsolete practice has morphed into a factoring company “sitting” on a received payment for a few days in order to accrue additional fees, paid from your money held in escrow.
Most factoring companies do things ethically, and when transactions are handled correctly, the arrangement is fair to everyone. That said, here’s what to look out for.
Assume your client pays your factoring company 28 days after invoice. That’s less than 30 days and is therefore considered on time. However, some factoring companies will build “clearance days” into their agreements – again, they’re in the minority. If your agreement calls for three clearance days, the factor would wait until day 31 before marking the invoice as paid, which entitles them to deduct an extra $250 from your escrowed funds before reimbursing you.
The same thing could happen if a payment comes in at day 43 or 44 and the company does not acknowledge receipt until after day 45. This delay would mean a total of $500 in combined extra financing fees. And remember, the client company is often charged the fee for the entire 15-day period, regardless of when the payment is actually received. Posting payments a day or two late can add up to hundreds of dollars in fees with the wrong invoice factoring provider.
Other factoring tricks and fees might include:
- Money transfer fees
- Wire transfer fees
- Application fees
- Due diligence fees
- New client fees
- Lockbox fees
- Termination fees
- Minimum funding fees
- Right to audit fees
- Fees for invoices that the factoring firm chooses not to fund
- Fees for funding fewer invoices than usual during a month
- Fees for same-day funding.
And if that’s not enough, some financing contracts will hedge their bets, adding language that they could charge fees to cover unnamed expenses their company incurs. It’s important to pay attention to the fine print and question what you don’t understand or feel comfortable with.
Let’s break down a few of the more common add-on fees that can add up for factoring clients.
- ACH transaction fees– ACHs should be free. They cost less than a dime, yet some companies charge $10 or more. We do not charge for ACHs, yet some factors do.
- Wire fees– Most companies do not need wires. Wiring money is an expensive option, and usually not necessary unless it is urgent. At MP Star, we actually do charge more for wires ($30) but only to discourage them.
- Credit checks and due diligence fees– At MP Star, we take responsibility for the cost of doing business with you. We’re happy to have you as a client, and we keep our fees to a minimum.
If you’d like us to take a look at your factor agreement or proposal, we’re happy to. Take the No Hidden Fees Challenge. Send us your current contract or proposal from another factoring company and we will show you the hidden fees and save you money. If we cannot save you money, we will pay you $250 in cash. Learn more.
- Ask for Documentation. If something seems suspicious, it’s okay to ask if there’s been a mistake in calculating the fees you have paid. For example, if a long-term client has been known to occasionally be five or six days late, but never as much as 17 or 18, you should probably make a polite inquiry. Ask when the factoring company marked the invoice as received and for verification of when the funds were deposited to its bank.
- Ask the Source. If payments are posted as late, consider calling your client’s accounts payable department. Explain that you’re working out some kinks in your receivables and banking arrangements and were wondering when the payment was authorized, signed and sent. If there’s more than a three-business-day gap in the mail-to-deposit timeline, you should ask the factoring company for clarification.
- Bank Lockbox. Only work with a factoring company that uses a bank lockbox, not a P.O. Box. Bank lockboxes timestamp all payments, and you can request a copy of a check from the bank lockbox the event that you are concerned. Factoring companies know this, and an ethical factor will provide timestamped checks upon request.
Although dishonest factoring businesses are rare, it always pays to be proactive and aware.
Remember, the factoring business is overwhelmingly represented by responsible professionals who understand that they can only succeed if their clients succeed, and that the factoring transaction is based on a level of trust that must be established with every customer.
That said, make sure to do your own due diligence. Be prepared to ask questions if you think you’re not being treated fairly.
AR Factoring Advice
While some factor companies focus on short-term profits, MP Star Financial focuses on long-term relationships. Trust MP Star as a strategic partner to help you get the funding you need, faster, through their one-fee factor approach. Find out if they’re a good fit for you by calling 877-292-1904, ext. 150 right now, or click here to schedule 10 minutes to learn more.
Invoice Factoring Tip #1: Ask for referrals, then ask for references. Remember what they say about an ounce of prevention. If you’re careful about who you work with, you’re much less likely to run into trouble later. Ask your accountant or another business associate you trust to recommend a few reputable factoring companies. After speaking with each factoring company, ask for the contact information of current clients. Prepare questions and explore the relationship as much as possible.
Invoice Factoring Tip #2: Avoid getting locked into a long-term invoice factoring contract. For a company new to factoring receivables, or for a seasoned factoring client looking for a new factor, a long-term invoice factoring agreement may lock you into the wrong factoring relationship, which can create a great deal of stress. Leave your options open so you can kick the tires with a factor to find the right relationship for your company. If things are going well, your factoring company should be thrilled to have you, and you should be happy to be there. Long-term contracts benefit your factor not you.
Invoice Factoring Tip #3: Be wary of come-on introductory rates. Hidden fees abound when factoring receivables, but not at MP Star Financial.
Invoice Factoring Tip #4: Many super low rates come with a catch, such as monthly minimums or inactivity fees. Look for a factor that is flexible and will work with the ebb and flow of your business. Don’t be fooled by high credit limits being offered. As flattering as it might seem to receive a credit limit that far exceeds your needs, it may be a clue that your proposal includes monthly minimum fees. Usually, monthly minimums are directly calculated using your credit limit. Monthly minimum fees are often calculated by multiplying your “high credit limit” by your factoring fee for a month, so your minimum factoring fees (regardless of your activity) will reflect your credit limit.
Invoice Factoring Tip #5: Understand exactly when your customers’ checks are being applied to your open invoices. Many factors will receive payments and wait several days for the checks to clear before they are applied to the open invoices. The advent of Check 21 has eliminated the need for “clearance days” to wait for checks to clear by most banks before being applied. So if you choose a company that waits, know that these “clearance days” only serve to increase your invoice factoring fees.
Invoice Factoring Tip #6: Go with an accounts receivable factor company that uses a bank lockbox as opposed to a private lockbox or post office box. As mentioned earlier, if payments seem to be taking too long, banks provide detailed reports (upon request) on when checks arrived. This will help you, too, make sure your customers payments are being applied on time and you are not being improperly charged with clearance charges.
Invoice Factoring Tip #7: Keep a copy of your contract, along with any addendums, in a safe place. If there is ever a dispute, you will need to have this agreement to review. In addition, if you do have a long-term agreement, you will need to refer to the contract and any addendums to know when you are eligible to terminate your agreement. Note that many times the term of the contract is reset with each addendum, and the date on the latest addendum dictates when you are eligible to terminate the invoice factoring relationship. This last point is very important, if you sign a one-year agreement today, many contracts require as much as 30 to 60 days’ notice prior to the anniversary date of the contract or the latest addendum to terminate or renegotiate the terms or it is renewed for another year. Long-term contracts are designed to benefit the factor, not you. You should avoid them as much as possible.
Invoice Factoring Tip #8: Make sure your factoring partner offers secure 24/7 online reporting. Make a point of looking at and printing out your reports each week. Promptly dispute any discrepancies. Oftentimes errors or improper charges that are not reported in a timely manner cannot be disputed later. Most factoring agreements include an “Account Stated” clause. The Account Stated clause limits your ability to go back over your account for errors after a certain period of time has passed. Usually, you are limited to the previous 60-90 days. (Note that this is not necessarily a “trick” by most factors – most factors are happy to review your account if there is any error – but it does place the onus upon you to review your account periodically.)
Invoice Factoring Tip #9: Watch your aging receivables carefully and keep after your collections. Time is definitely money in factoring – the faster your collections come in and get posted, the lower your invoice factoring fees will be over time. Do not fall into the trap of losing track of your receivables. Nobody, including the very best factoring company, will care as much as you about collecting your money. Staying on top of your collections will help minimize your factoring fees.
Invoice Factoring Tip #10: If your factor provides other services, such as payroll tax payments or payroll service, always get a monthly report of all transactions. Remember: you are responsible for making sure bills and taxes are paid and making sure items such as W-2s are mailed out. If there was ever a computer crash and your data was lost, the IRS will be looking to you to provide that information.
Invoice Factoring Tip #11: Always look for an IRS certified payroll or Certified Professional Employer Organization (CPEO). There are countless examples of payroll and PEO companies that fail to make their/your payments and reports. The IRS does not care! Unless your payroll provider or PEO is certified (a CPEO), payments and reporting not done properly is your responsibility, even if your PEO was supposed to handle it on your behalf.
Invoice Factoring Tip #12: As part of the factoring relationship, your factor will notify your clients about the change in the remittance address. Many companies panic and fear this process because they do not want their customers to know they are factoring receivables. However, we suggest that you use the standard remittance notifications as a positive and as an opportunity to sell your services or products. This is an excellent chance to explain to your customers that you have received new funding, which will help you to continue to grow and continue to provide excellent service.
We’re Here to Help
MP Star Financial can help you get a better handle on your company’s cash flow management. Call us at 877-292-1904 Ext. 150 or get in touch.
Ready to Change Factoring Partners?
Find out how MP Star Financial and their One-Fee Factoring takes the stress out of business cash flow using your accounts receivables to get you the money you need. Apply today and get One-Fee Factor funded, without being nickel and dimed.