For many companies — from one-man businesses to large corporations — waiting for customers to pay is a regular source of frustration. You provided the needed goods or services, but you still need to wait weeks or months to get paid. Meanwhile, you have your own expenses.
With invoice factoring you can get cash for outstanding invoices. We researched invoice factoring lenders to help you get the money you need.
Last Updated: December 2, 2019
Invoice Factoring – The Solution to Many Problems
If you’re frustrated by late payments, you’ve probably been less than thrilled at the recent popularity of extending payment terms. In fact, in some industries, long payment terms have become the norm. It is hardly surprising, then, that many small businesses experience cash flow issues when their capital gets stuck in unpaid invoices and cannot be funneled back into the business immediately.
This can be a stressful situation for business owners, especially if the financial health of the company is at stake or when the company is having a hard time meeting its own financial obligations or maintaining its good credit score.
Naturally, business owners look for ways to improve their cash flow. One of the popular business funding options is invoice factoring, which gives you access to your capital without having to sell equity or take on debt.
Still not sure if invoice factoring is right for you? Read on to learn more about this creative debt
What is Invoice Factoring?
Invoice factoring is a kind of financing where you can get cash advance for your unpaid invoices. It can also be called a lot of other terms, such as accounts receivable factoring, receivables factoring, AR factoring, invoice financing, accounts receivable financing, receivables financing, AR financing or just plain factoring.
Take note, however, that even though many companies use the terms invoice factoring and invoice financing interchangeably, the two are technically different. We will discuss the difference later on in this guide.
How does invoice factoring work?
A factoring transaction involves three parties:
- The client — the company that issues the invoices
- The customer (also called account debtor) — the company that owes the client money for the goods and services received
- The factor — the company that provides funding to businesses in exchange for outstanding invoices
After providing goods and services, a company (the client) sends their customer an invoice. The customer has a financial obligation to pay the client, who owns the invoice. The invoice is a financial asset that gives its owner the legal right to collect money from the customer.
The client then sells the invoice to a factoring company in exchange for an immediate cash advance amounting to a percentage of the invoice value (typically 70%-90%). The ownership of the invoice transfers to the factor, which gives the factoring company the legal right to collect the debt from the customer.
The factor gives the cash advance to the client, holds the remaining amount as reserve, and takes over payment collection from the customer. Once the customer pays the invoice, the factor takes out its fee (called the factoring fee or discount fee) from the reserve then forwards the rest (called the rebate) to the client.
The transaction benefits all the parties involved:
- The client gets funds immediately
- The customer enjoys better payment terms
- The factoring company earns a fee
The factoring fee is a percentage of the invoice value and is usually calculated on a weekly or monthly basis. To illustrate simply, a 1% weekly factoring fee on a $100,000 invoice means that the factor will charge $1,000 every week the invoice remains unpaid. Some factoring companies also charge a processing fee, typically around 3%. Those fees are essentially the price you pay to have cash on hand now instead of weeks later.
Let’s look at a specific example to make things clearer.
Let’s say that you have an outstanding invoice worth $100,000, due in 4 weeks. You approach an invoice factoring company and apply for financing with your invoice as collateral. Your contract specifies that the advance rate is 85%, the factor fee is 1% per week, and there is a 3% processing fee.
This is what will happen: You immediately get 85% of the invoice value as advance ($85,000) and the factoring company holds the remaining $15,000 as reserve. If your customer takes 4 weeks to pay the invoice, the factoring company deducts the 3% processing fee ($3,000) and the 4% factoring fee ($4,000) from the reserve and sends you the remaining $8,000 as rebate. All in all, you get $93,000 from your $100,000 invoice.
Invoice Factoring Types
When it comes to invoice factoring, you have two options. Their difference lies on who takes on the risk.
This is the standard kind of factoring. With recourse factoring, you take on the risk. If the customer does not pay for whatever reason, you will have to pay the factoring company its fees and the total borrowed amount.
Because this arrangement is less risky for factoring companies, they typically charge lower fees for recourse factoring transactions. If your customers are creditworthy, this will likely be the better choice for you.
With non-recourse factoring, on the other hand, the risk falls on the factoring company. The factor will shoulder the loss if your customer does not pay up. Because of this risk, the advance rate that comes with this arrangement is lower and the fees are a lot higher and may not be worth it.
Will Invoice Factoring Help My Business?
Now that you are more familiar with the concept of invoice factoring, you might be wondering if and how your business will improve from this kind of financing.
At one point or another, a business will need a quick cash infusion. Without enough cash on hand, the company might have a hard time paying for necessary expenses or grabbing opportunities that will take it to the next level. This is especially true for companies that invoice their customers for large sums of money and have especially delayed payment terms, such as in government contracts, corporate clientele, and multi-phase contracts. Moreover, many business owners have received a late payment from a commercial customer at least once. In fact, more than half of invoices are paid late.
As a business owner, you have several options for financing but many of them are hard to qualify for, not immediately available or insufficient for your needs.
This is where invoice factoring comes in.
Invoice factoring quickly frees up capital that is tied up in outstanding invoices, providing you with immediate capital that you can flexibly use for any business needs. Instead of waiting for weeks (or months) to get paid, you can use your invoices to have access to funds within a day or two. With improved cash flow, you can now operate your business more smoothly.
The fees associated with invoice factoring can sometimes be high, but many businesses still choose invoice factoring over other types of financing due to its speed and low risk. The products and services have already been sold, the work has been completed, and the invoice has been confirmed. You are just waiting for the payment. As long as you trust that your customer will fulfill its financial obligation to you, you do not have to worry about paying the advance. You can just focus on growing your business or settling your business expenses.
The following are just some of the issues and opportunities where the immediate funds from invoice factoring can help you:
- Paying for unexpected expenses
- Covering important and urgent expenses (such as payroll, rent, and taxes) during short-term cash flow shortage
- Buying supplies and inventory
- Paying off existing debt
- Taking on new work or large orders
- Expanding or improving your business
- Investing on new equipment
- Taking advantage of discounts your suppliers give for bulk buys and early payments
- Hiring additional workers
- Meeting seasonal needs
- Reducing collections and administration costs
What Types of Businesses do Invoice Factoring Companies Work With?
Invoice factoring companies work primarily with business-to-business (B2B) or business-to-government (B2G) companies that invoice their customers. If you have a business-to-consumer (B2C) company or do not issue invoices to your customers, then factoring is not for you.
Industries that usually use invoice factoring are manufacturing, transportation, trucking, oil and gas, and wholesale. It is a lot easier for B2B companies to qualify for invoice factoring than traditional business loans. Compared to other lenders, factoring companies do not care as much about the company’s profitability, annual revenue or age of the business. Some will also look at your credit score and financial history but will still consider you even if those two are less than stellar.
This is because your outstanding invoices act as collateral. So, when making their decision, factoring companies are more interested in the amount and quality of your invoices and the creditworthiness of your customers than in your own financial qualifications. The more creditworthy your customers are, the more likely it is for factoring companies to approve your application for financing.
It is also very important that your invoices are not pledged to other loans. That means you cannot use the same invoices as collateral for other loans. In addition, your company should not have a history of serious legal or tax issues.
Some invoice factoring companies also decline companies that offer payment terms exceeding 90 days. This is because of a theory that customers are less likely to pay more than 90 days after the issuance of the invoice.
Invoice Factoring vs. Bank Loans and Other Kinds of Conventional Business Financing
Invoice factoring is similar to business loans in some ways, but it is technically not a business loan. Both options can help you get funding for your business needs but there are notable differences, such as:
Invoice factoring is not considered debt
Because factoring companies purchase your unpaid invoices, you are not taking on any debt. Unless your customer fails to pay the invoice, you do not have to worry about paying the factoring company. In contrast, business loans are debts, and debts can become a burden weighing down a business and a big source of stress for business owners.
There are more parties involved
Traditional business financing options involve only two parties: you and the lender. Meanwhile, factoring involves three: the factoring company, you, and your customer.
Funding decisions depend on different things
With traditional business loans, lenders decide if you qualify and for how much based on your financial and business history, such as your bank statements, credit score, and tax returns. On the other hand, the factoring companies’ funding decision depends on the credit quality of your customers. This means even relatively new or not very profitable companies can get funded as long as their customers are established businesses or the government.
The approval rates are different
According to a report published by Forbes, big banks now approve 25.9 percent of funding requests they receive, a post-recession high – but that still leaves many companies without the money they need. Invoice factoring has a higher approval rate compared to bank financing, so you can still qualify even if you have had a hard time qualifying for a bank loan or other types of traditional financing. As long as you have outstanding invoices issued to creditworthy customers, you are likely to be approved.
Application and approval speeds differ
Bank loan applications can take months and involve a lot of paperwork, which can be quite frustrating given their low approval rate. In contrast,applying for factoring is faster, simpler, and needs a lot less paperwork. Most factoring companies have an online portal where you can submit the requirements.
Approval is also quicker, typically within only 1-2 business days. You get the money right away, enabling you to immediately grab business opportunities that come your way or take care of problems caused by short-term cash shortage.
Advantages and Disadvantages of Invoice Factoring
There are many reasons to use invoice factoring to infuse capital into your business, but just like any other financing method, it is not the best choice for all kinds of businesses. So, before you enter an agreement with a factoring company, make sure that you have considered all the pros and cons of invoice factoring.
Advantages of Invoice Factoring
We have touched on some of the upsides of invoice factoring earlier. Now let us take a deeper look and discuss additional advantages.
You get business capital even though your customers have not paid yet
You do not have to wait for your customers to pay just to have money for your business needs. You can grab opportunities and take care of expenses now, instead of weeks or months later.
You are not restricted or stressed out by debt
Because you do not take on debt with invoice factoring, you can use the funds more flexibly. There are no restrictions on how you can use the money.You also do not have to worry about monthly payments. The monthly payments associated with business loans are stressful for business owners, who sometimes end up choosing between paying the bank or taking care of payroll or utilities.
Getting funds through invoice factoring is fast
With invoice factoring, the application process is simple, and you can secure funding for your business relatively fast. In some cases, the money will be in your business bank account the same day you apply. This is because factoring is a short-term, low-risk kind of financing, which encourages factoring companies to require less paperwork and speed up their process in order to be competitive, as well as be less thorough in their underwriting.
In contrast, bank loans and other traditional business loans can take weeks or even months to approve applications. If you need the funds urgently, then invoice factoring is obviously the better choice.
It is easy to qualify for invoice factoring
Banks and other traditional business lenders do not just take a long time to approve loans but also have very strict requirements and low loan approval rates. They also involve a lot of paperwork and will scrutinize your personal and business financial health and history.
In contrast, you can qualify for invoice factoring financing even if you do not qualify for traditional types of business loans. The outstanding invoices already serve as collateral, so you do not need to have additional collateral to even apply.
In addition, because the funding is secured by the invoices, the factoring companies will evaluate your application based on the credit history of your customers, not yours. This means as long as your invoiced customers are creditworthy, you can still get approved even if your business is still new or has less than impressive credentials.
You can reduce overhead by outsourcing collections
Because factoring companies purchase your invoices, they will take care of collecting payment from your customers. This can cut down your administration cost and lower your business overhead. You also won’t have to make repeated follow-ups on late payments, which can be a source of stress especially if you are busy or do not have the manpower to collect payments efficiently.
Take note, however, that in some forms of invoice factoring, such as invoice financing (more about invoice financing later), you — and not the factoring company — are the one responsible for collecting payments, so if outsourcing payment collections is an advantage that appeals to you, make sure to clarify that with the factory company.
Disadvantages of Invoice Factoring
Now that we have discussed the positive aspects of invoice factoring, let us talk about the downsides.
It is limited to B2B and B2G companies
Because invoice factoring depends on invoices, it is only available to businesses that issue invoices to their customers, i.e. B2B and B2G companies. In addition, there might be invoicing minimums, so if you have low outstanding payments you may not qualify.
The fees are higher compared to traditional business financing
Invoice factoring is more expensive than business credit cards and conventional lines of credit. This is because of the short repayment term and the high fees. The processing fee plus the factoring fee add up to a high percentage of the invoice value for just a short period of time, which translates to a high interest rate. The astronomical fees might be worth it, depending on your company’s circumstances, but before committing to an agreement with a factoring company, be sure that you completely understand the costs and are willing to pay them.
If your customer does not pay, you will have to pay
In most factoring agreements, you take on the risk of non-payment. If the customer does not pay, you will have to pay the factoring company the total borrowed amount plus the fees.
Approval and interest will depend on your customer’s creditworthiness
The creditworthiness of your customer is a double-edged sword. If your customer is reliable and responsible with its financial obligations, your application will be approved and the interest rate will be low. On the other hand, if your customer’s credit rating is not so good, you will have a higher interest rate.
The fees can add up quickly if the customer is slow to pay
The fees that the factoring company will deduct from the reserve will depend on how quickly your customer pays up. If your customer settles its financial obligation immediately, the factor fee won’t be too bad, especially if the invoice amount is high. However, you can end up paying a high fee if you have slow-paying customers. It is therefore important for you to review your previous transactions with your customers before making a decision about invoice factoring. It will not only help you decide if invoice factoring is a good option for you – it will also help you choose which invoices to sell. In general, it is better to sell invoices issued to customers that pay the full amount immediately.
The factoring company will be the one to collect payments from your customers
Because the invoice has been purchased by the factoring company, that company now owns the invoice. This usually means that company will take over payment collection and will thus communicate with your customers.
Whether this is a good thing or a bad thing will depend on you and your business, which is why this disadvantage is also listed as an advantage. If collecting payments from your customers is something you consider stressful or inconvenient, then the factoring company doing it will be a welcome relief.
However, this can be a deal breaker if you do not want your customers to know that you are factoring invoices. You also won’t be able to control the interaction between the factoring company and the customer, which might be an issue if the factoring company is not as professional and courteous as you are when collecting payments.
If the customers need to send their payment directly to the factoring company, this can also lead to confusion or negatively affect your relationship with your customers in other ways. Furthermore, customers that know about your factoring arrangement might assume that your business is having financial problems and is therefore at risk. This impression might cause existing customers to leave, while scaring off potential customers.
But worry not; if you are interested in invoice factoring but do not want another company collecting payments from your customers, you have another option: invoice financing.
Invoice Factoring vs. Invoice Financing
As mentioned at the beginning of this article, many companies use these two terms interchangeably. However, while the two are very similar, they have a few differences, the most important of which is that with invoice financing, you get the cash advance but still remain the owner of the invoices, so you are still in charge of payment collection. The factoring company will therefore not be interacting with your customers.
Another difference is that with invoice factoring, you will have to agree to let the factoring company do a credit check on your customers. If they fail these checks, your application may be denied. In contrast, with invoice financing, the creditworthiness of your customers is not the only determining factor. This is because fintech invoice financing companies use high-tech methods to evaluate businesses.
In addition, with invoice financing, you can get the whole invoice amount as long as you are okay with paying the associated fees. With invoice factoring, on the other hand, you only get a portion of the invoice value. You first get the advance then after your customer has paid, the factoring company deducts its fees from the reserve then sends you the rest. Lastly, while both invoice factoring and invoice financing are much faster than conventional business loans, invoice financing is typically faster than invoice factoring.
How do I apply?
Applying for invoice factoring is quick and simple. It usually takes only a few minutes and requires only a few documents. The most important thing in your application is the invoice, as that determines the funding amount as well as the terms of the agreement. Most factoring companies accept online applications. Some connect to accounting software, such as QuickBooks and Xero, enabling the client to easily enter the details of the invoices he is submitting. These are the documents needed to apply for invoice factoring:
- Outstanding invoices
- Driver’s license
- Voided business check
- Bank statements
- Credit score
Applications are usually approved within a business day or two.
How To Choose the Best Factoring Company
There are hundreds of companies to choose from. How do you decide which one is the best?
As you evaluate and compare factoring companies, it is advisable to ask each company to provide information about all the fees that they charge. When it comes to fees, transparency is key. Check that all fees are clearly stated in the factoring agreement to avoid undesirable surprises.
Be careful with factoring companies that are not fully transparent with the cost of doing business with thh4. In addition, be wary of companies that advertise very low factoring rates then hit you with a lot of hidden fees. If finance is not your expertise, it might be better to consult an accountant or lawyer to be sure.
Other things to look out for are high fees and lack of adequate communication. High fees might mean the company underwrites so fast that they suffered losses that they are now trying to recover through their clients. An impersonal touch, meanwhile, can leave you clueless as to why certain things happen, such as why some of your invoices were rejected.
You can also evaluate the factoring companies by how long it takes them to approve applications and release the funds.
Also take note of the age and reputation of the companies. You can gauge the reputation of the factoring companies by checking the reviews they have received from their clients. These reviews will give you an idea on how satisfied their clients are and what your experience with the company will be like.
In addition, because invoice factoring companies will be contacting your customers during collection, it is also a good idea to ask the companies about their customer support. Find out how they will communicate with your customers and decide if that will be acceptable.
Another thing to consider when choosing a factoring company is if it allows contract factoring or spot factoring.
With spot factoring, the client can sell a single invoice to the factor. This is favorable to the client but not to the factoring company because a single invoice is inefficient considering the time and effort the factor spent in processing the application. An individual invoice might also mean a low amount, which makes the client a lower value client compared to others. In this case, the factoring agreement will have higher fees and stricter terms.
With contract factoring, on the other hand, there is a long-term contract and factoring companies take on invoices based on value, instead of picking single invoices. This means there might be a minimum volume per month or that the client needs to submit all invoices to the factor while the contract is active.
Contract factoring is common but rigid and not favorable for small businesses because their customers have different payment terms or changes in financing.
We also strongly recommend checking the factoring company’s familiarity with your industry. If you have a real estate business, for example, it is better to choose a factoring company that specializes in real estate factoring because it is trusted in your industry and is knowledgeable about how real estate companies do things.
Finally, you should make sure to read professional reviews of every potential invoice factoring company to get the scoop on how exactly the company works, its fees, and other things to expect during the application and funding processes. These reviews should give you a good idea which company is the best fit for yours.
With this popular small business financier, invoice factoring applications can be done completely online and takes only 5 minutes. The terms are simple and transparent and business owners can get factoring lines ranging from $5,000 up to $5 million, with rates as low as 0.25% per week. You can submit as many invoices as you want and get an advance amounting to 85% to 90% of the invoice amount.
BlueVine integrates with popular accounting software, such as Xero, FreshBooks, and QuickBooks but can also work with clients that do not use any accounting or invoicing software. The initial application is generally approved within 24 hours and subsequent ones within only a few hours. The expertise of BlueVine lies in multiple industries but the company does not work with clients from the gambling, firearms, car dealership, and adult entertainment industries. To qualify for financing, your business needs to be least 3 months old, with a credit score of 530 and $100,000 in annual revenue.
Triumph Business Capital
Triumph Business Capital provides invoice factoring services in the trucking, freight, staffing, oil and gas, and small business industries.
Its advance rate is around 90% while factor rates range from 1% to 4%.
Like BlueVine, Triumph typically approves applications within 24 hours. However, unlike BlueVine, Triumph handles the collection of payment and interacts directly with your customers.
Fundbox is another reputable business financing company. It has a TrustScore of 9.7/10 and an overall rating of “Excellent” on TrustPilot, as well as an A+ rating with the Better Business Bureau.
Unlike the previous two companies, Fundbox advances the full invoice value. Application only takes minutes and approval only a few hours. The credit limit is $100,000, with fees starting at 4.66% of the drawn funds.
Fundbox is similar to BlueVine in that it does not communicate with its clients’ customers. Your customer pays you directly and you pay Fundbox every week for 12 or 24 weeks. The company supports several accounting software but also works with clients that have no accounting program. It can also connect to business checking accounts from most national and local banks and credit unions.
Fundbox’s fees are transparent and straightforward and you can save on fees if you repay early.
Questions to Ask
After you have decided that invoice factoring is a good fit for your business, ask the factoring companies you are considering these questions before committing to an agreement.
What is the advance rate?
Different companies advance you different percentages of the outstanding invoice. Some offer higher percentages than others. Make sure that you are getting a good rate and that the advance you will get is enough to cover your needs.
How much is the processing fee?
Most factoring companies charge a processing fee right off the bat. You will be paying that amount no matter what, even in the best case scenario. Make sure you are comfortable parting with that amount of money.
What is the weekly fee for my outstanding invoice?
Different factoring companies charge different factoring fees. If you have slow-paying customers, the fees can get really high, so make sure you have a good idea how much the transaction will cost you and if you can actually afford those fees.
How many invoices can I factor?
Some factoring companies allow as many invoices as the client desires, while some only factor one invoice at a time.
Is it required that I have an accounting software?
Some factoring companies only accommodate clients that use an accounting software, so clarify this point before proceeding. If you use an accounting program, make sure that it is compatible with the company’s system.
When do I need to pay back the advance?
Some companies require you to pay the advance back within a specific time frame. Others get repaid when your customer pays the invoice. If the factoring company you are considering has a set payback period, make sure you will be able to repay the funds if your customer’s payment is delayed.
Can we easily work together again?
Business owners experience cash flow issues every now and then. When problems arise, it is nice to have an invoice factoring company that you already trust, so ask the factoring company what repeat transactions with them would be like.
Who owns the debt?
Some factoring companies own the debt and collect payments from their clients’ customers, while some leave the debt and the collection to the client. Make sure that it is clear to you where the factoring company stands regarding these two things and that the company is aligned with your preference.
How will you interact with my customers?
Some factoring companies take over payment collection, some don’t. If you prefer your customers to not know that you are factoring your accounts receivable, choose a company that lets you do the collection yourself. If you are okay with the company communicating with your customers, make sure their representatives are professional and respectful.
The Bottom Line
Invoice factoring is a quick and effective way to boost a company’s growth and improve its cash flow issues. Just like any other forms of financing, however, it has advantages and disadvantages that business owners need to consider. With this guide, you now have a better understanding of how it works and if it is right for your business.