Watch out for sneaky invoice factoring tricks
Invoice factoring can be a great financing option for your growing company. Factoring can get money into your bank account faster and make your cash flow much more predictable, which in turn lets you stay current on your payroll and tax obligations, make your payments to vendors on time, and concentrate on running your business rather than chasing down receivables.
But you need to be careful.
Like most industries, invoice factoring is made up of responsible, ethical business people who do the right things and serve their clients honorably. But, as is the case anywhere, there are players who, given the opportunity, will sometimes not act in the customer’s best interest.
In particular, one sneaky trick to factoring involves a factoring company “sitting” on a received payment for a few days in order to accrue additional fees to be paid from funds held in escrow.
What your invoice factoring company SHOULD do
Say you elect to factor a $25,000 receivable. The transaction might break down as follows:
Note: Advance rates and financing fees are samples. Actual rates and fees will vary.
Receivable Amount: $25,000
85% Advance: $21,250
Less Initial Financing Fee: $875
Advance to Your Company: $20,375
Amount Held in Escrow: $3,750
If the invoice is paid on time (30 days), the full amount in escrow ($3,750) is paid to your company.
Here’s where things can get a little sketchy. If the invoice is paid after 30 days, an additional $438 (1/2 of the original financing fee) is charged for each 15-day period, or part thereof, that the invoice remains outstanding. So, in this example, another $438 would be charged if the invoice were paid after 45 days. These additional fees would be applied to the funds held in escrow.
All this is acceptable, standard, and spelled out in the agreement in which you entered into the factoring arrangement. Make sure everything is clearly defined and explained to your satisfaction before you sign.
Factoring tricks: what your invoice factoring company should NOT do
Again, most factoring companies do things the right way, 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 considered on time. However, a dishonest factoring company – again, they’re in the extreme minority – could wait until day 31 or 32 before marking the invoice as paid, and deduct an extra $438 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. That would mean a total of $875 in extra financing fees. And remember, you’re charged the fee for the entire 15 day period, regardless of when the payment is actually received.
How to Protect Yourself Against Sneaky Invoice Factoring Companies
Ask for Referrals. 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 reputable factoring companies. After speaking with each factoring company, ask for the contact information of current clients.
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 of 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 mail-to-deposit timeline, you should ask the factoring company what happened.
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 due diligence, and be prepared to ask questions if you think you’re not being treated fairly.
One solution is to let Triad Business Capital handle the factoring company vetting process for you Free of charge. Just message us on our contact page or give us a call! One of our factoring experts will be more than happy to help you!