It’s common for businesses that rely on accounts receivables to run into cash flow problems. Invoices often aren’t due for 30-90 days, potentially leaving you without the capital you need to take on new work.
Factoring is one way to keep your company’s cash flowing, relying on your accounts receivables to qualify for an advance of what customers owe you. This short-term financing may be especially helpful if you’re not able to qualify for traditional business loans.
What exactly is invoice factoring?
Invoice factoring is a type of business financing in which a business sells their unpaid invoices to a factoring company at a discount. The company typically gives businesses between 75% and 90% upfront and then the rest of the funds after your clients pay up — with a fee subtracted.
Businesses can use their funds for any legitimate purpose like working capital. It can be expensive, so you might want to consider less costly financing like equipment loans if they’re available to your business.
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Is invoice factoring the same as invoice financing?
It isn’t. Invoice factoring technically isn’t a loan. Instead it’s an advance with a 2-step process that doesn’t involve repayments or interest. When you sign up for invoice factoring, the factoring company typically handles invoice payments from your clients and gives you the funds after your clients pay up.
On the other hand, invoice financing is a secured business term loan backed by your business’s unpaid invoices. You repay it in installments over a set period of time with interest and fees. And you’re still in charge of collecting on your invoices.
Recourse vs. non-recourse factoring
There are two main types of invoice factoring in Canada.
Recourse factoring: This is a common type of invoice factoring in Canada. In this case, the factoring company buys your accounts receivable with the understanding you are still on the hook for any invoices it can’t collect.
Non-recourse factoring: The factoring company assumes all risk for uncollected invoices. Even if the bill goes unpaid, your company is not liable. Since the factoring company takes on more risk in this scenario, the cost is usually higher.
How to apply for invoice factoring?
You don’t really apply for invoice factoring, per se. But you do have to qualify in the eyes of the factoring company. “Getting set up with a factoring company generally takes 7-10 days. It involves filling out an application, submitting some documentation, agreeing on terms, signing a contract and submitting invoices for funding,” says the website of Meritus Capital, a US company that offers such services.
Interest rates
Factoring can be expensive when compared to the cost of traditional lines of credit. When deciding what to charge you, factoring companies would typically look at how long it has taken your customers to pay invoices in the past, how your company’s invoicing system works, and whether your company has any outstanding tax or legal issues.
“Costs are based on the amount of financing you need and the creditworthiness of your clients. Invoice factoring rates range from 1.5% to 4% per 30 days depending on these criteria,” according to the website of Commercial Capital LLC Canada.
How the process works
The process for invoice factoring is straightforward.
Send the invoice to the factoring company.
The factoring company then pays you the aforementioned 75% to 90% of the invoice’s value.
Your client then pays the invoice to the factoring company (hopefully on schedule).
The factoring company then sends you the remaining cash (i.e. the remaining 10% to 15% of the invoice) after subtracting a fee for the factoring service.
How can I find the right factoring company for my business?
When looking for a factoring company that works best for your business, ask yourself the following questions:
Is my business eligible? While factoring companies are relatively lenient about who they’ll take on, you often must satisfy at least a few requirements requirements. Don’t waste your time with a company that ultimately won’t work with you.
Does it accept invoices from my clients? Many factoring companies work with B2B (business-to-business) and B2G (business-to-government) companies, but your business might work with other types of clients.
How much can I get up front? Make sure your advance is enough to cover your business’s overhead costs.
How does the factor fee work? Tiered factoring and prime plus can save your business money if its invoices are due within 30 days. If you have longer due dates, you might want to look for a fixed rate.
Are there any other fees? Look for administrative and processing fees in particular. Some companies charge extra fees for optional services like wire transfers.
How much will it cost? After you’ve narrowed down a few companies, crunch the numbers for a rough estimate of how much working with each company might cost.
Bottom line
They’re not lenders, but factoring services can be helpful for businesses looking to cover overhead costs — especially if you have trouble qualifying for business loans. But the process takes time and money, given the fees involved.
It depends. Some companies require you to set up a separate bank account they can access, asking your clients to make payments there. Others contact the business or agency to collect the funds themselves.
From the factor fee and any other fees it charges you for the service. Generally, you could be loaned up to 85% of the value of your invoices and receive the remaining amount less the factor fee later. The factor fee is could be around 0.5%-4% per month.
Debt factoring is another term for invoice factoring. It’s not a common term, but you’ll see it used in the UK and other countries.
Anna Serio is a lead editor at Finder, specializing in consumer and business financing. A trusted lending expert and former certified commercial loan officer, Anna's written and edited more than 1,000 articles on Finder to help Americans strengthen their financial literacy. Her expertise and analysis on personal, student, business and car loans has been featured in publications like Business Insider, CNBC and Nasdaq, and has appeared on NBC and KADN. Anna holds an MA in Middle Eastern studies from the American University of Beirut and a BA in Creative Writing from Macaulay Honors College at Hunter College, CUNY.
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