What is Invoice Factoring?
Invoice factoring is a financial service used to boost a company’s cash flow. Invoice factoring is not a loan. A company sells its unpaid invoices to the factoring company at a discount. The factoring company provides immediate capital for those invoices. The factoring company now owns the invoices and will collect according to the payment terms of the unpaid invoices from the customer who is being invoiced, typically 30-60 days.
Let’s take a look at a sample invoice factoring scenario:
A contractor doing maintenance for municipalities is billing for completed work but won’t collect payment for 30-60 days. In the meantime, he needs to pay his employees and purchase materials for his next job. In order to solve his cash flow problem, he chooses to factor his invoices. Once his service is completed, he send his invoice to the factoring company instead of the municipality, his customer. The factor verifies completion of work and advances up to 90% of the invoice within 24 hours. The factor sends the invoice to the customer and will collect payment in 30-60 days. Once the factor is paid, the remaining 10% of the invoice value will be paid to the contractor, minus the factoring fee.
Key Benefits of Invoice Factoring
Maximum Cash Flow
Financial Freedom
Total Flexibility
Bad Debt Protection
How Invoice Factoring Works
- Your company provides goods or services to creditworthy customers and submit correct invoices.
- Your company sells its unpaid invoices to an invoice factoring company.
- A factoring company verifies the invoices and then funds your business with immediate payment. You get up to 90% of the invoiced amount the same day.
- Your customers make payment directly to the factoring company according to the terms of the invoice. The factoring company then returns the balance of the paid invoice minus a fee.
How Is Invoice Factoring Different Than a Bank Loan?
Invoice factoring can be an excellent option for companies that need money quickly but who aren’t able to secure a conventional bank loan. Many refer to business factoring by several names such as receivables factoring, invoice discounting, invoice factoring and debtor financing.
The net result is that your company can convert its receivables into immediate operating cash. That way, you will not have to wait 30, 60, 90 days or more for your customers to pay. In this blog post, we explore how invoice factoring is different than a bank loan.
Invoice Factoring Pros and Cons
There are benefits and drawbacks to every type of financial support. Bank loans may require a strong credit report or collateral to secure your loan, while other types of financing may ask for part ownership of your company or future earnings. Invoice factoring has some pros and cons, too.
The Pros of Invoice Factoring
Fast Business Capital
Invoice factoring can provide immediate working capital to help cover a cash flow gap caused by slow-paying customers.
Improved Cash Flow
You can keep loyal customers on longer payment terms but still improve your cash flow to help you grow your business.
Easier Approval
Invoice factoring provides financing to companies that might not be able to get capital from other sources, such as a traditional bank, because of a lack of collateral, a limited operating history, or poor personal credit. Typically, factoring companies base approval on the value of the invoices you’re looking to factor and the creditworthiness of your customers.
Bad Debt Protection
Non-recourse factoring essentially provides accounts receivable insurance, along with the cash advance.
The Cons of Invoice Factoring
Not All Invoices Qualify for Factoring
The invoice must be for a B2B transaction. And the service must be completed before the factoring company will purchase the invoice.
Customers’ Bad Credit or Weak Finances Could Derail Your Financing
The factoring company will need to verify the creditworthiness of your customers. If the customers have a history of late or missed payments, or if the business has weak revenue, you may not be approved for the financing.
No Guarantee of Collection
There’s no certainty the invoice factoring company will successfully collect on your unpaid invoices. If it’s a recourse factor, the factoring company may require you to buy back the unpaid invoice. If you can’t afford to risk customer non-payment, make sure the factoring company you choose offers non-recourse factoring.
How Are Invoice Factoring and Invoice Financing Different?
Invoice financing, also known as accounts receivable financing, is a bit different from factoring. Instead of selling your invoices to a factoring company, you use the invoices as collateral to get access to working capital and you remain responsible for collecting payment on the invoices. Accounts receivable financing is a form of asset based lending, more similar to a loan, where the line of credit is based on the value of your accounts receivable. Qualifying for accounts receivable financing, is also more similar to qualifying for a loan. You must have a certain number of years in business and provide financial statements to show profitability.
How to Select a Factoring Company
Selecting the right factoring company for your business is extremely important. A factoring company is not solely a source of working capital for your business; in many ways, a factoring company functions as a partner. You will be in contact with the factoring company on a regular basis and they will also be responsible for invoicing your customers. With this in mind, below is some criteria to consider when when choosing an invoice factoring company:
- Experience and Financial Stability – There are many factoring companies to choose from, more come and go each year. You will want to choose a company that has a proven track record and a solid financial backing. You should look for a factoring company which has diversified funding sources and that will be around for many years to come.
- Customer Service – Will you be working with an assigned team with direct emails and phone numbers, or will you be sent to a call center and constantly be speaking with a different representative? Where will your support team be located? Are they near you or in your same time zone? These are important things to consider in order for a factoring company to give you the best service, and be able to function as your partner.
- Favorable Terms – When it comes to factoring rates, it’s important to not solely consider the factoring fee (the discount amount per invoice). There are many variables when it comes to factoring rates, additional fees, contract terms, and monthly minimums. All of these should be discussed prior to committing to a factoring company. For more on factoring costs, visit our blog on invoice factoring pricing variables.
- Reputation – What is their reputation in the industry? You should do some research and be able to find information from third party sources.
- Industry Experience – The factoring company you work with should have experience working with other companies in your industry. There are nuances in each industry and your factoring company should know the invoicing procedures & systems and lingo of yours.
Ultimately, you will have to consider how important each of these items is for your business and look for an invoice factoring company that will provide you and your business with the best combination of experience, service, and terms. You’ll want to find a partner and arrangement that offers you the funds, flexibility, transparency, and terms that works best for you.
History of Factoring
Invoice factoring is a type of business financing that’s an alternative to conventional business loans. A factor buys invoices from a business, allowing it to get cash up-front rather than having to wait for customers to pay. This type of financing has quite a few benefits, especially for smaller businesses that may not qualify for substantial bank loans. Although this type of financing has gotten more popular in recent years, it’s actually been around for some time.
Factoring can be traced back to ancient times. It was used extensively during the Roman Empire. This was helpful for merchants who conducted business in faraway places, as Rome was one of the first global empires. Factors made it possible for these merchants to fund expeditions and to do business during slow seasons. The ancient world was largely dependent on agriculture, where weather, as well as local economic conditions, resulted in great fluctuations in crop price. Factors provided merchants with the resources that helped them survive and even thrive even when conditions were less than ideal.
Today, factoring is widely used by businesses in every B2B industry as a source of working capital to fund daily operations.
Common Questions About Invoice Factoring
Are you a good fit for invoice factoring?
In order to be a candidate for invoice factoring, you must be invoicing other business customers for delivered goods or services. If you have sales, but cash flow issues are preventing you from keeping up with business expenses or increasing sales, then invoice factoring will benefit your business.
Is invoice factoring a loan?
Invoice factoring is not a business loan, rather a form of business financing. There is no money to be repaid and no long-term commitments. Instead, it is an advance on a business’ existing accounts receivable. The unpaid invoices are actually sold to the factoring company for immediate business capital.
What types of companies use invoice factoring?
Businesses in many different stages and industries use invoice factoring to help their business grow and expand. Factoring is suitable for start-ups, growing companies, and any businesses who can’t always wait 30-60 days for business customers to pay. Invoice factoring is a flexible form of financing that grows with a company as their financing needs change. Riviera Finance works with the following industries, among others:
Blog Posts About Invoice Factoring
The following blog articles may be helpful in understanding invoice factoring and how it can help your business grow.
How Invoice Factoring Works – In 6 Easy Steps