Invoice Factoring — The Secret Cash Flow Weapon for Startups

Your Amazon business could be taking advantage of a technique that’s been around for a thousand years — if only you knew about it.

Before you read about this secret weapon, take this two-question quiz to determine if you should be using it:

  1. Does your business earn revenue via an online marketplace (like eBay, Amazon, Shopify, or Etsy) that takes a week or more to get you payment for your sales?
  2. If your business’s cash flow improved, would you invest more in inventory (or other growth initiatives)?

If you answered “no” to either question, factoring might not be for you — you might benefit more from these pieces on Amazon SEO or Buy Box optimization.

But if your answer is “yes” to both questions, it’s likely you should be considering a powerful, flexible type of financing you’ve probably never heard of.

Invoice Factoring for Amazon Sellers

Ok, you have me… What is it?

Invoice factoring.

In essence, invoice factoring is a way to turn your revenues into cash faster than normal.

If you sell online through a marketplace like Amazon, it usually takes between 14 and 90 days for Amazon to pay out your sales. You see, just because a customer has agreed to purchase your product doesn’t mean you’re any richer yet — on Amazon, sellers still have to get their payments processed. This is a truth every Amazon seller knows.

Invoice factoring is a deal you can make with a third party company. They buy your (slow, yet-to-be-processed) accounts receivable in exchange for cash.

Run that by me again? Here’s an example to illustrate how it works.

Sara is a lifelong triathlete and cycling nerd. Her new Amazon Store sells high-end, performance bicycles. Manufacturing costs for one bike are $1,000 and each bike takes one week to make. A bike retails for $2,000 so the profit is $1,000 per bike. In January, Sara sells her entire inventory (five bikes) in the first week, making $10,000. (Great!) She ships out her inventory to the buyers. Meanwhile, Amazon is processing her payments. Amazon doesn’t remit the money for two weeks. Sara doesn’t have the cash on hand to replenish her inventory, so she has to wait. Meanwhile, she doesn’t have any bikes to sell. In the third week of January, Amazon remits payment, and Sara invests her profit ($5000) into new inventory. The new batch of bikes is ready to sell by the first week of February.

Sara sold $10,000 in January.

Now let’s see what that scenario looks like if Sara had set up an invoice factoring agreement to advance payments on her Amazon seller account in December.

Sarah sells the same five bikes that first week in January. Once Sara sells a bike, her partner, an invoice factoring company, pays her the day after her sale. (They take 2% as payment and withhold another 20% until Amazon remits payment). By the end of the first week, Sara has sold five bikes and received $8,000 in cash payments. This time, she has the cash to immediately get to work on five more bikes. By the third week in January, the new batch of bikes is ready to sell. Meanwhile, Amazon finally remits payment… to the third party company (at which point the company can then pay Sara the remaining reserve of 20% they were withholding, minus the 2%. fee). By the fourth week of the month, Sara is again able to sell her inventory, again receiving advance payment from her factoring company.

Now Sara has sold $19,600 in the month compared to the $10,000 she would have sold if she hadn’t replenished her inventory.

Her business is 92% more profitable.

Accounts Receivable Invoice Factoring – Why does it work?

The power of invoice factoring is all about cash flow.

In the example above, each transaction Sara makes is actually slightly less profitable when she uses invoice factoring. She has to pay for the services her invoice factoring partner are providing, so she makes less $40 less on each bike she sells.

However, that $40 buys her something much more valuable: flexibility.

Since Sarah is dodging a huge cash-flow killer (in this case, Amazon’s payout delay), she is able to reinvest in inventory more frequently and sell significantly more units. In this example, the increased volume enabled by factoring her invoices is well worth the cost.

The Nitty-Gritty Details

Invoice factoring has been around for centuries. Businesses needing better cash flow is nothing new, and while modern factoring looks different on the surface, the fundamentals are the same. This is exactly how factoring works:

  • You agree to have your invoices factored, working with your invoice factoring partner to set up payment methods and assign them the rights to your accounts receivable.
  • The factoring company gives you cash today in exchange for the legal right to your accounts receivable, which will come due tomorrow. It’s not a loan. Instead, you’re simply getting cash now in exchange for your legal right to a payment later.
  • A factoring company usually charges a percentage fee for this service. Typically the fee is 1-3% of the total invoice. This “fee” actually comes in the form of your partner buying your accounts receivable at discount.
  • The factoring company usually withholds 10-20% of your overall payment as protection in the case of customers whose payments fail. Any withheld amount is paid to you once a customer’s payment goes through.

That’s it. You’ve effectively paid a percentage fee for access to improved cash flow, which you can use to grow your business.

When Invoice Factoring Isn’t Right

This example should make the value of invoice factoring pretty clear, and thousands of small businesses have adopted it as a core part of their financial strategy (including Payability customers). But let’s take a look at when factoring doesn’t make sense. Factoring might be wrong for you if:

  • You can’t use the capital. Having access to better cash flow is only important if spending cash will help your business. Replenishing inventory, paying employees and suppliers, undertaking marketing initiatives… There are a million places companies need to sink cash in order to make great products and grow. But keep in mind that factoring your invoices costs some money, so if your business is already cash-rich or has other sources of revenue, factoring may not be helpful.
  • Something else is cheaper. Factoring is great for a lot of reasons, but you typically pay for it with a percentage fee. This is in contrast to paying interest as you would with a bank loan or line of credit. This can potentially make factoring your invoices more expensive than taking out a loan. If you have strong credit, a defined scope for your investment, and time to wait for approval, a loan or credit card may be a better solution.
  • Your payment terms don’t create cash flow problems. If your company already has revenue flowing in evenly, the expedited payment schedule provided by invoice factoring might not be helpful. This isn’t usually the case for Amazon sellers — slow payment processing is a universal problem for online sellers. However, if you have revenue flowing in from other sources on a regular basis, you might be able to use that revenue to fund your growth instead of a factoring arrangement.

Benefits of Invoice Factoring

Assuming your business can benefit from improved cash flow, then factoring has many benefits. These are a few of the key characteristics that make invoice factoring a good fit for a lot of businesses:

  • Growth-enabling. Above all else, factoring is a weapon in your growth arsenal. It lets you say yes to purchasing new inventory, undertaking sales and marketing initiatives, and growing your operations.
  • Predictable and transparent. When you factor your invoices, you know exactly what you’re getting. Your costs will be 100% transparent, and you’ll always know how much cash you’ll have access to and when you’ll have access to it. This stability is of enormous value to any business decision maker.
  • Transactional. The factoring company takes no equity in the business, letting you retain complete control.
  • Obtainable. It’s usually very easy to engage in a factoring agreement. Unlike a bank loan, you don’t need a good credit score to get your invoices factored, and approval rates are very high.
  • Fast. Because of how easy it is to get approved and how simple the logistics are, you can begin seeing improved cash flow within days of expressing interest.
  • Consistent. One you are engaged with a factoring company, payments will come in automatically, with no delays, no hiccups, and no doubt. It’s one of the best ways to ensure you can run your business smoothly.

How to Factor Your Invoices

If you’re interested in speaking with Payability, our sales team can help you understand the process of invoice factoring more fully. We’re helping Amazon sellers every day — in some cases seeing their businesses grow by 2.5x — by advancing daily payments to them so they don’t have to wait to get paid.

For more financing options, check out Fit Small Business’ list of the best 6 Best Small Business Line of Credit 2019.

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