Choosing a factoring company to help you finance your small business can be a rather intricate process, but the best factoring companies tend to make everything clear and concise. Sadly, not all factors are the same, and some may have some details in the fine print that clearly negates the promises of their promotions or advertisement.
Take the promise of high advances, for example. A factor may boast that they advance as much as 90% of the value of an invoice and that’s better than getting 80% or even less. You now have more money to pay for overhead expenses and payroll.
But in the fine print, you encounter several unfamiliar business finance terms that may limit the amount of money you get in advance. So let’s take a look at these terms and clarify some common issues. To explain things better, let’s assume that you took up an offer of 90% cash advance on the value of the invoices you want to be factored.
This is the period after which the factor takes its cash advance back. It’s usually for 90 days, although it can be negotiated with the factor. If you’re just starting your financing with the factor, then any invoice you have that’s unpaid after 90 days won’t qualify.
Once the funding starts, if any customer of yours doesn’t pay within the recourse period, then the factor will take the value of the cash advance from your other invoices. In other words, if you have two invoices worth $20,000 each and you got your $18,000 advance from invoice #1, but your customer did not pay within the specified period, then the factor will need to take out the money he advanced to you from invoice #2.
The debtor limit is the maximum value of an invoice / invoices for a particular customer of yours. Let’s say that your factor will only approve of $10,000 per customer. So even if you only have 5 customers with accounts receivable of $20,000 each, you can only get an advance for $10,000 each. That means you will receive a $9,000 cash advance per invoice, so you get $45,000 total.
This is another limit on how much debt will be funded for a single customer, but in this case the limit is a percentage of the total funding. So if the concentration is a generous 100% then it’s ok with your factor that you only have 1 customer. But if the concentration limit is 20% and you have only 2 customers owing you $50,000 each, then you can only get a cash advance for $20,000 each. And that means even if you are supposed to receive a 90% cash advance, you won’t get $90,000 from the $100,000 value of your two invoices. You only get a total of $18,000.
Look for these business finance terms in the fine print before signing your name on the dotted line. The best factoring companies will explain it thoroughly for you, but you can’t expect all factors to be clear and upfront.