If your company offers 30 to 60-day payment terms to customers and you're having trouble waiting for cash, you can take advantage of spot factoring. It's a unique financing facility that funds a large portion of your invoices upfront and, in many cases, in as little as 24 hours.
Spot factoring companies can offer anywhere between 80-90% of your invoice amount upfront. The remaining balance, minus fees, is given to you once the customer pays the invoice. Unlike traditional factoring where you'd provide all your invoices for financing, spot factoring allows you to finance an individual invoice or a single batch of invoices.
Spot factoring can only be used by companies that provide 30- to 60-day payment terms to customers. It can be a source of funding to consider when you need quick access to cash for lumpy trading periods, unexpected growth opportunities or emergency situations such as making repairs or covering payroll.
First, spot factoring companies verify each invoice you submit by looking at the creditworthiness of the customer (called a "debtor') paying the invoice. The invoice must be payable within 30-60 days. Once you agree on fees and terms, you'll receive your funds at about 80% of the total invoice amount. The spot factoring company will also provide debt collection services.
Once your customer pays the invoice to the spot factoring company, you'll receive the remaining amount of the invoice (usually 20%), minus fees and charges.
How to compare spot factoring options
Here are the main points of difference when looking at spot factoring options:
Advance rate. Also called a factor rate, this is the amount the spot factoring company will pay off your invoice and is expressed as a percentage. An 80% advance rate would mean you'd get 80% of the invoice amount upfront.
Service fee. This is a one-time fee charged on every invoice you submit for financing. The fee is based on the total value of your invoice and can be anywhere from 0.1% to 20%.
Discount rate. This is a fixed percentage rate charged on your advanced funds. It's calculated daily and charged every month. It can range from anywhere between 2% to 10% of the total amount advanced to you.
Due diligence/document fees. These are initial setup costs for the spot factoring company to cover credit checks and other work needed to advance funds. These can be anywhere from a few hundred to a few thousand dollars.
Other fees. There may be other ad hoc fees associated with your factoring facility. Make sure you're aware of all the fees associated with each option you're considering.
What are the pros and cons of spot factoring?
Great way to ease your cash flow troubles. You can quickly gain access to funds and, depending on the particular spot factoring company, you can receive your money in as little as 24 hours.
You may still qualify with bad credit. Since the creditworthiness of your customers is the main factor invoice financing companies look at, you may still qualify with bad credit. However, you won't be able to qualify if your account receivables have been pledged as security for another lender.
Unsecured. Spot factoring is not a form of lending, as your invoices are "purchased" upfront by the spot factoring company. As a result, you won't be required to put up your home or business equity as collateral.
It can be expensive.Out of all invoice financing options, spot factoring is usually the most expensive since you're working on a per-invoice basis. This increases setup costs for spot factoring companies.
Depends on creditworthiness of debtors. Your ability to qualify almost entirely depends on the creditworthiness of the customers paying your invoices. Don't bother financing the invoices linked to customers with shaky credit.
Is there anything to avoid?
Keep in mind the following pitfalls if you're considering spot factoring:
Paying more than you can afford. Since spot factoring can be expensive, make sure you're fully aware of all fees and charges. Once you figure out the costs involved, conduct a cost-benefit analysis to see if you can afford it. Also, be aware of other traditional financing options such as short-term loans or a business line of credit.
Using spot factoring as an ongoing source of funding. Because of the way spot factoring is set up and the costs associated with it, you should not use spot factoring if you have ongoing requirements for finance, such as on a monthly basis. Instead, use spot factoring when you urgently require funding for a one-off situation like taking advantage of a business opportunity or trying to make payroll.
FAQs about spot factoring
Spot factoring companies don't technically lend you money. Instead, they purchase the invoices from you at a discounted rate. This is an important distinction in Australia, where lenders must meet specific guidelines to ensure responsible lending.
This depends on the spot factoring company. Some require you to refund the advanced funds you've been given. Others take on the full risk. If there is insurance on the invoices, the insurance company will pay.
While there may be some exceptions, you usually need to be in business for at least six months to qualify for spot factoring.
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Elizabeth Barry is the lead editor for Finder. She has over 10 years' experience writing about a range of topics with a focus on personal finance. You’ll find her writing and commentary in a range of publications and media including Seven News, the ABC, MSN, the Irish Times and Singapore Business Review.
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