Even a successful business can find itself with a cash flow shortage, but invoice factoring can help you solve that problem. For the right type of business, the approval process is fast and straightforward, but it’s not the cheapest type of business funding.
Not to be confused with invoice financing — where you borrow against your outstanding invoices but still retain control of them — invoice factoring involves selling your unpaid invoices to a third-party firm that takes over the collection process.
Invoice factoring — sometimes known as debt factoring — is a type of small business revenue-based funding where a business sells its outstanding invoices to a factoring company at a discount, in exchange for cash, based on the value of those invoices.
The factoring company pays your business a percentage of the invoices’ total value up front — typically 80% to 90%. Once the customer pays, the factoring company sends you the remainder of the invoice total minus its fee.
Most of the time, factoring companies have a recourse agreement. This means if a customer fails to pay its bill, you’ll have to repay the advance. However, you may be able to get a non-recourse deal where the factoring company assumes most of the risk, but this is a more expensive option.
And, most commonly, the factoring company handles the invoices after you sign up, and customers are notified that the invoices have been assigned to the factoring company. Some factoring firms offer the option of confidentially managing your receivables by essentially acting as an extension of your business. This move could be a good idea if you’re concerned that customers might see the sale of their invoices as an indication that your business is struggling — no matter what the reality is.
Businesses that invoice most of their customers often have a significant period between when invoices are sent and when they get paid — usually 30 to 90 days. This can sometimes create gaps in cash flow that invoice factoring aims to bridge. It usually works like this:
Let’s say your company has a $20K invoice due from a customer. After you invoice the customer, you submit the invoice to the factoring company. The factoring company purchases your invoices for 80% of its face value at a 5% fee.
The factoring company deposits $16,000 into your account, supplying you with immediate cash flow. Once your customer pays its invoice to the factoring company, it sends you the remainder of the invoice amount, less its 5% fee.
In this scenario, you would get back an additional $3,000 ($4,000 of the remaining invoice balance – $1,000 fee = $3,000), for a total of $19,000.
| Invoice total | $20,000 |
| Factor fee of 5% | $1,000 |
| Initial advance from factoring firm (80%) | $16,000 |
| Remainder of invoice | $4,000 |
| Remainder of advance minus fee | $3,000 |
| Net from invoice | $19,000 |
Factoring companies vary in how they structure fees, but you should expect to pay somewhere between 1% and 5% of the invoices’ value. The exact rate depends on the amount you hope to get, the total of your outstanding invoices, the creditworthiness of your customers and other factors.
You may also be charged other fees, including application fees, services fees, or late fees if a customer doesn’t pay their bill on time. Be sure to ask about any extra fees you might be on the hook for — a low factor rate may not be worth it if other fees are too steep.
Invoice factoring is usually best for B2B companies that carry a substantial amount of outstanding invoices. It might also be a good option if your credit profile isn’t in great shape, since approval is based more heavily on the value of your invoices — and the reliability of your customers — rather than your credit score.
To be approved for invoice factoring, you’ll need to have some, if not all, of the following:
You may also need to submit recent bank statements or other business financials and it’s possible you could be subject to a credit check.
If you meet the basic eligibility requirements for invoice factoring, you’re ready to seek approval.
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Sometimes, people confuse invoice factoring with invoice financing, but there are a few key differences. Most notably, invoice financing doesn’t involve selling your invoices. Instead, you take out a loan based on the value of your invoices and repay it as your customers settle their bills.
Invoice financing might be preferable to factoring if you want to maintain closer relationships with your customers and keep control of your accounts receivables. Plus, invoice factoring could cast doubt in the minds of your customers if they think you have cash flow problems — no matter how profitable you actually are.
However, if you have reliable customers, don’t want to take out a loan and would like to ease the burden of collecting payments, invoice factoring could be the right way to go.
Invoice financing is one alternative to invoice factoring, but there are several other funding options.
Invoice factoring provides a straightforward solution to borrowing money when you need a fast cash flow. It’s an effective financing option, especially if your credit isn’t perfect or you’ve had difficulties obtaining a more traditional business loan.
However, this invoice-based financing option can get expensive and may come with risks that are difficult to predict. Compare other funding options to make sure invoice factoring is right for your business.
Depending on your agreement with the factoring company, you may have to repay the advance if a business doesn’t pay what it owes, which could put you in a tight spot. It might be possible to shift more of the risk to the factoring company but expect to pay higher rates.
Even if a factoring company checks your personal credit score — which they may not — it’s generally more concerned with the creditworthiness of your customers than you.
That depends on the factoring company. Some factoring firms want to take over all or most of your invoices. But you may be able to request selective factoring, where you only use one or some of your invoices. For example, if you have one large invoice you want to be paid immediately, a factoring company may agree to a one-time deal.
Not necessarily. In most cases, customers are notified that their invoices have been assigned to a factoring company and that’s where they should now direct their payments. However, you may be able to use confidential factoring where clients aren’t notified that they’re paying anyone but you.
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Could anyone recommend a factoring company that has offered excellent service and a straight forward agreement? I had spoken to a few companies, and when I get the contracts, they seem to hide extra tricks to beef up their fees. I have a staffing agency. I would highly appreciate a recommendation from a user rather than a sales rep. Thanks, Ernesto.
Hi Ernesto,
Thanks for getting in touch with Finder. I hope all is well with you. 😃
As as a comparison website, I’m afraid I can’t provide specific recommendations. However, I would highly suggest that you check the factoring company we feature above. You can also compare business loan providers that offer factoring services by using our table. To directly get in touch with the providers above, please click the “Go to site” green button.
I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.
Have a wonderful day!
Cheers,
Joshua