Unfortunately, cash flow problems are common among Canadian small businesses. The reality is that, even though businesses do solid work and send invoices on time, they often have to wait weeks or even months to be paid. During this waiting period, expenses continue, and you need to find the cash, which is usually where invoice factoring for a small business comes into play.
Invoice factoring is arguably one of the most popular cash flow solutions for companies that want to pay expenses, maintain payroll, and continue growing. It’s a type of accounts receivable financing and a well-established alternative funding option in Canada on par with merchant cash advances.
If you’re interested in learning more about it, how to apply, the benefits, risks, and how it compares to other alternative financing, continue reading. Our team at Bizfund shares everything you need to know.
What Is Invoice Factoring?
So what exactly is invoice factoring for small businesses? You already know that invoice factoring is an alternative funding method, so to put things simply, invoice factoring is when you sell unpaid business customer invoices to a factoring company like FundThrough, Riviera Finance, and Rev Capital.
So instead of waiting for your business to receive payment from customers, you’ll receive most of the invoice values upfront from the factoring company. This company will collect payments from you once your customers have paid.
It’s important to note that invoice factoring is not a traditional loan. You won’t pay interest the way you would with a bank loan because the invoices will be listed as assets being sold.
How Does Invoice Factoring Work In Practice?
Invoice factoring for a small business is easy to understand because the process is straightforward. Let’s use your small Canadian business as an example. You will issue an invoice to a customer and specify payment terms of 30, 60, or 90 days.
Then you will submit this invoice to a factoring company of your choice. They will review the invoice and the customer’s credit profile, and whether your business receives approval often depends more on the customer than on your company.
If you secure approval from the invoice factoring company, they’ll advance a percentage of the invoice’s monetary value. This is typically between 70 and 90 percent. This money will usually be paid within a few business days. Once your customer pays the invoice, the payment will be sent to the factoring company. They will then release the remaining balance to you after deducting their fees.
Benefits and Risks
The Benefits
There are quite a few benefits for businesses if they choose invoice factoring in Canada. For example, companies can enjoy:
- Quicker working capital access when compared to traditional bank loan options.
- Not having to wait for customer payment cycles to experience improved cash flow.
- No traditional loans on the balance sheet.
- An emphasis on customer credit strength for approval criteria.
- Ongoing access to funds as the factoring company issues invoices.
With these benefits, factoring is especially useful to wholesalers, service providers, B2B companies, and manufacturers.
The Risks
Although there are many benefits, invoice factoring also carries risks. A few of the potential drawbacks include the following:
- The fees charged by invoice factoring companies reduce the total amount you’ll receive from each invoice.
- When customers take longer to pay their invoices, costs can increase and will come out of your bottom line.
- If the invoice factoring company communicates directly with your customers, it can negatively affect customer relationships.
- Some contracts can include minimum volume requirements.
- Long-term agreements can limit flexibility.
You’ll need to carefully assess these risks and whether an alternative financing solution, such as a merchant cash advance, would be better.
How to Apply
If your interest is piqued, you might want to learn how to apply for invoice factoring. Fortunately, the process is simple, faster, and still structured. Here’s a quick look at what to do:
- Choose the factoring company that serves your type of Canadian small business.
- Gather recent invoices and customer payment information, and prepare them for presentation.
- Submit your client invoices, along with aging reports, if the invoice factoring company requests them.
- Allow the factoring company time to review the customer credit profiles linked to the invoices.
- If approved, receive the funding.
Once you secure approval, you can continue submitting new invoices under the agreement and access ongoing working capital.
Practical Use Cases for Small Businesses
Invoice factoring is most effective when cash flow timing, not a lack of sales, is the primary issue for a company. Below, we share practical use cases of when invoice factoring could be a good idea:
- Businesses selling to other businesses: For many B2B companies, invoices may not be paid for several weeks or longer because of net payment terms. Invoice factoring helps shorten the payment waiting period by converting unpaid invoices into working capital. It can keep your business operating without cash flow disruptions.
- Seasonal businesses experience fluctuating revenue: Unfortunately, seasonal businesses often have slower months. During these slower months, expenses remain constant, so cash flow is essential. With invoice factoring, companies gain access to cash tied up in receivables, helping combat cash flow issues.
- Growing businesses needing to manage upfront costs: Often, expanding businesses in Canada take on new contracts that require upfront spending on labour, materials, or logistics. This cash flow need comes before customers pay their invoices, so invoice factoring helps fund this growth. With these funds, companies don’t have to always rely on traditional bank loans.
These are just a few practical use cases that demonstrate how invoice factoring can benefit Canadian small businesses.
Comparing Invoice Factoring With Other Funding Options
Although invoice factoring is a form of alternative funding, there are many other types of financing available to small businesses.
To make sure you choose the right funding option, it’s a good idea to compare invoice factoring with different financing options, including traditional loans.
Let’s look below at how invoice factoring for a small business compares to merchant cash advances, conventional bank loans, and invoice financing, which, believe it or not, are different.
Invoice Factoring vs Merchant Cash Advances
With invoice factoring, the financing you receive is based on unpaid invoices for work you completed, and whether or not you get this funding is dependent on the credit strength of customers. In contrast, merchant cash advances work differently. With an MCA, you gain access to upfront capital based on your expected future sales rather than on invoices.
With Bizfunds MCAs, your repayments adjust based on your sales. You can also borrow up to $300,000, which you can use for whatever needs you have for your small business. With this in mind, merchant cash advances are best suited to businesses with steady daily sales, while invoice factoring is better for companies that invoice clients and face payment term delays.
Invoice Factoring vs Traditional Bank Loans
Traditional bank loans in Canada typically have stricter approval processes than invoice factoring. With traditional loans, a lender has to review your business credit history, collateral, and financial statements.
In addition, approval timelines can be longer than with invoice factoring, especially for newer businesses, since invoice factoring focuses on customer payment reliability and accounts receivable.
Moreover, bank loans tend to create long-term debt, and you have to follow fixed repayment schedules, and there are interest rates to contend with, too. Invoice factoring differs in that it converts your receivables into cash without adding a loan obligation to your plate.
Invoice Factoring vs Invoice Financing
They may sound similar, but invoice factoring and invoice financing are not the same thing. With invoice financing, you’re using unpaid invoices as security for a loan, but with invoice factoring, you’re outright selling invoices. You won’t keep ownership of your invoices like you would with invoice financing. In addition, with invoice financing, you remain responsible for collecting payment, while with invoice factoring, the factoring company is responsible for collection.
Invoice Factoring for Small Businesses: Key Takeaways
Invoice factoring for small businesses is a smart move if you want to secure working capital without waiting for clients to pay. However, it does come with drawbacks, such as fees, and is reliant on customers’ credit profiles.
Fortunately, if you don’t want to pursue invoice factoring and alternatives like invoice financing or traditional bank loans aren’t an option, merchant cash advances are an option. In many situations, merchant cash advances offer more benefits and fewer drawbacks, especially for businesses that don’t rely on net payment periods.
So, if you want to learn more about MCAs or apply for one, you can do so here with Bizfund. We offer fast and reliable financing across Canada, giving small businesses access to funds when they need them.
