Is Invoice Factoring Possible with Bad Credit?

poor credit score

Last Updated on November 2, 2022

Your business might turn in a profit on paper, but if cash flow is limited, covering operational expenses can be a challenge. For businesses with bad credit or a limited credit history, using credit to cover expenses isn’t always the best solution.

Invoice factoring is a better alternative while you build your business credit or work on improving a low score.

How Does Invoice Factoring Work?

Did you know that 43% of small business owners say that keeping up with operating challenges is a challenge? Most businesses have 30-day or sometimes longer terms for paying invoices. While you wait for a payment from a client, you might struggle to find the cash to pay for invoices from your suppliers, or take care of expenses like payroll, rent, or even utility bills.

With invoice factoring, you can get money right away for your unpaid accounts receivables. An invoice factoring company will give you a certain percentage of the value of your invoices. The company will then collect payment from your customers at the end of the invoice term.

Once the invoice factoring company has collected payment, you will receive the remainder of the invoice value minus a fee.

The main benefit of factoring your invoices is a predictable cash flow. If customers don’t pay on time or decide to use the full term of the invoice, you’ll still have access to cash to take care of your immediate expenses and liabilities.

Another advantage is that the invoice factoring company is in charge of collecting payments from your customers. Invoice factoring can help you save a lot of time, especially if you have to send multiple reminders at the end of an invoice term, and you can focus on other important tasks.

Related: Spot Factoring

How Do Invoice Factoring Companies Determine Their Terms?

Invoice factoring companies will typically adjust their rates and fees and the percentage of the accounts receivables they can give you upfront based on a few factors.

These service providers will look into your customer base to assess the risks they are taking by giving you cash upfront for your accounts receivables. They will also look at your industry, the volume of invoices you want to factor, and the average number of invoices that are outstanding.

If you have a long history of working with the same customers who always pay you on time, you will get better terms for invoice factoring. The invoice factoring company will also offer a higher upfront percentage for your accounts receivables if you have a large customer base since working with multiple customers makes you more resilient in case one of them doesn’t pay an invoice.

On the other hand, working with customers that you acquired recently can make you eligible for less advantageous terms. However, you can negotiate a recourse or non-recourse contract with an invoice factoring company:

  • A recourse contract means that you will buy back any unpaid invoices. You can get better terms since you’re taking on the risk of having a customer not pay an invoice, and the invoice factoring company won’t lose any money in this scenario.
  • Invoice factoring companies also offer non-recourse contracts. If you opt for this option, the factoring company will absorb the loss if a customer doesn’t pay an invoice. You will pay a higher fee for this service since the invoice factoring company is taking more risks.

Does Your Credit Score Matter for Invoice Factoring?

The answer is no. Your invoice factoring provider is going to look at your accounts receivables to determine the terms they can offer. They focus on money that customers owe you and how likely these customers are to pay invoices on time.

Your business credit score has no impact on the invoice factoring application and approval process. It also has no impact on the rates you will get.

A business with bad credit or a limited credit history can qualify since your credit doesn’t reflect your ability to receive money from your clients. Your personal credit score isn’t particularly important either.

However, the invoice factoring company you choose to work with will look into the creditworthiness of your customers.

If you sell goods and services to customers who have bad credit scores or a limited credit history, the invoice factoring company will consider that these customers are more likely to fall behind on paying invoices or that their risk of going bankrupt is higher.

As a result, the invoice factoring company may offer a contract with higher fees or with a smaller percentage of the accounts receivables that you can get upfront. It’s something you can offset by choosing a recourse contract so that you can buy back any unpaid invoices and reduce the risks the invoice factoring company is taking.

You can also get better terms if you can grow your customer base or factor a higher volume of invoices. If the invoice factoring company is paying you upfront for a higher number of invoices, the impact of a customer getting behind on their payments will not be as devastating.

Will the Invoice Factoring Company Do a Credit Check?

Invoice factoring providers have a vetting process designed to assess the creditworthiness of your customers. This process includes a credit check.

Looking into the credit history of your customers tells the invoice factoring company whether they are managing their credit lines responsibly and paying invoices on time.

Having multiple customers with a good credit score and a strong credit history means you will qualify for better invoice factoring terms.

However, working with customers who operate new businesses with a limited credit history or who have bad credit scores won’t disqualify you from invoice factoring. It just means you’ll get a smaller percentage upfront or only qualify for a recourse contract.

You can also get better terms if you have a large customer base rather than relying on a few major clients for the bulk of your cash flow. The more clients you have, the smaller the impact of an unpaid invoice will be.

If you want to mitigate risks and get better terms, focus on acquiring new customers that have been around for a while. An older business should have more experience with managing credit and their creditworthiness should be higher.

Will Invoice Factoring Affect Your Credit?

Your business credit score is a number that ranges from 0 to 100. Just like with your personal credit score, you can improve this score by paying your creditors on time. It will also go up if you manage your business credit lines responsibly and have had the same credit lines for years.

Invoice factoring has no direct impact on your business credit score. Factoring gives you access to an immediate cash flow when you issue an invoice instead of waiting until the term of the invoice. Your business credit score only reflects the payments you make, not the ones you receive.

However, invoice factoring gives you access to a predictable cash flow. Getting paid faster for your invoices makes you less likely to miss a business loan or credit card payment. A late payment can cause your credit score to dip significantly, which is why cash flow is so important for improving your credit score.

Factoring also makes you less dependent on credit. You’ll have sufficient cash flow to cover your operational expenses and can reserve your credit lines for things like unexpected expenses or investments. It’s easier to plan for optimal credit utilization when you have a predictable cash flow.

If you combine invoice factoring with using your cash flow to manage your credit lines responsibly, invoice factoring will help you improve your business credit score.

How Invoice Factoring Supports Growth

Obtaining financing can be tough for news businesses. A limited credit history means you can qualify for secured credit lines or pay higher fees to borrow money.

In fact, 46% of small business owners end up using personal credit cards to finance their business ventures. They might qualify for better terms, but it means that they will remain liable for any debt the business incurred, even if they go bankrupt.

Invoice factoring can improve your cash flow and help you keep up with operating expenses and liabilities without having to rely on credit. You can establish trustworthiness with your partners by never missing a payment, and you can also focus on building your business credit score by using a loan or credit card to finance major purchases.

When the time comes, you will have a strong credit score and few liabilities and will qualify for a credit line you can use to purchase new assets or finance a large project that will help your business grow.

Wrapping Up

Bad credit or a limited credit history won’t get in the way of your business qualifying for invoice factoring. With the right invoice factoring company, you’ll get paid faster for your invoices and will benefit from a predictable cash flow you can use to keep up with expenses and manage your business credit lines.

However, the creditworthiness of your customers can have an impact on the terms the invoice factoring company can offer. You’ll get better terms if you have a varied customer base or work with customers who have strong credit histories.