Invoice Factoring Questions, Answered
What Is Invoice Factoring?
So what is invoice factoring? Invoice Factoring is a way for businesses to boost their working capital without having to take out a traditional loan or damage their credit rating. The process involves selling your unpaid customer invoices (accounts receivable) to a third party, known as the factoring company, at a discounted rate. The factoring company will pay you a large percentage of the invoice value upfront and work on collecting payments from your customers for you. This means you will have immediate working capital to pay your suppliers or cover payroll, expansion, and other operating expenses – all without accumulating debt. Once your debtors have settled their invoices, the remaining balance will be refunded to you minus a small factoring fee.
Who Uses Factoring?
Almost any business that sells services or goods to other companies could be eligible for invoice factoring. This is because, unlike a traditional loan, the applicants for factoring are usually approved or rejected based on the creditworthiness of their customers rather than their own credit scores. So, a short or poor credit history usually won’t disqualify you from being approved as long as your customers have a strong payment history.
The more lenient and flexible approval requirements for factoring make it one of the most accessible financing solutions available today. Small businesses, midsize companies, startups, and large corporations across multiple industries make use of factoring every day. Some of the most common industries that use factoring include the transportation, staffing, manufacturing, government contractor, and oilfield industries. You can explore how invoice factoring works in each industry on the relevant industry page.
How Can Factoring Help a Business?
There are a number of ways that factoring can help businesses, but the main benefit is that companies can get paid immediately for work they have completed instead of waiting weeks or even months for their clients to pay them. Invoice factoring is a great way to stabilize your cash flow. Plus, the factoring company typically won’t restrict what you can spend that money on, so you can cover payroll, hire new staff, pay your fixed expenses, start saving, or invest in your business growth.
How Is Factoring Different From a Bank Loan?
Factoring is one of the most convenient alternatives to traditional financing options like a bank loan or line of credit. There are a number of features and benefits that set this financing solution apart. First, it is debt-free. You are not taking out a loan based on extensive collateral or unpredictable future income; you are simply getting an advance on money that is already owed to your business. Invoice factoring doesn’t even require collateral, nor does it accumulate expensive interest. As factoring is based on outstanding accounts receivables, not your net worth, you do not have a limit to how much financing you can receive. You also can be approved right away for advances, regardless of your business background, credit score, or collateral, because factoring companies look at your customers’ creditworthiness rather than your own.
How Does Factoring Affect the Factoring Client’s Customers?
If you choose to factor your invoices, the factoring company will send a Notice of Assignment to your customers to let them know that they will be assuming ownership of the invoices. Many of your clients may already be familiar with the invoice factoring process and won’t have a problem with you factoring their invoices. Their original service contract will still be with you; the only thing that is changing is where they will be sending their payments. Reputable factoring companies will have well-trained and courteous collections professionals who will treat your customers with the same courtesy and respect that they treat their own clients – protecting your customer relationships.
How Much Does Invoice Factoring Cost?
The cost of factoring will differ depending on which company you partner with, so you may need to shop around to find the best match. Still, factoring rates are usually a lot more affordable than the interest charged on bank loans. Some factors will charge you a flat fee per invoice, while others will charge you a percentage fee that they base on a number of factors, including the industry your business operates in and the creditworthiness of your clients. Typical factoring fees fall between 1% and 5%, but this will vary from factor to factor. It is also important to read your factoring agreement carefully to avoid being surprised by hidden fees and costs.
Do you want to learn more about invoice factoring? Our Invoice Factoring Guide details everything you need to know about factoring, from what to look for in a factoring company to a complete breakdown of the factoring process, its benefits, and any costs you may face.