A Complete Guide to Invoice Factoring

Invoice Factoring is a convenient, fast, flexible, and accessible financing solution available to both fully-established businesses and start-ups. It’s a cost-effective and efficient way to raise capital without taking on additional debt. In this guide, you’ll learn everything you need to know about factoring, including:

The best way to ensure that your overall experience with factoring is as convenient and profitable as possible is to educate yourself on the ins and outs of the entire process and everyone involved in it. That way, you know that your business is getting the cash flow it needs to operate and grow and that you have partnered with a factoring company that you can trust to help you reach your financial goals.

Once you make it to the end of this comprehensive guide, you’ll have all the information and knowledge you need to make informed decisions about everything from the factoring company you choose to the type of factoring that would benefit your business most.

Invoice Factoring is a convenient, fast, flexible, and accessible financing solution available to both fully-established businesses and start-ups. It’s a cost-effective and efficient way to raise capital without taking on additional debt. In this guide, you’ll learn everything you need to know about factoring, including:

Invoice factoring is one of the easiest and most popular ways for companies of all sizes to improve their financial standing – and fast! Also referred to as accounts receivable factoring or invoice financing, this alternative financing solution pays companies upfront for money already owed to them – the money tied up in their AR processes. 

So what is factoring? Factoring is a financing solution that fills the cash flow gap left by slow-paying clients by giving companies an upfront and immediate advance on their invoice payments. It is one of the fastest, easiest, and most affordable ways for companies to obtain the financing they need to cover important business expenses like payroll, business expansion, and other operating expenses. Companies can speed up their cash flow without having to wait up to 90 days (or longer) for their customers to pay them. Plus, because factoring is not a loan, it is debt-free. Receivables financing can be a game-changer for businesses that need quick access to working capital.

If you’re looking for a definition of invoice factoring, it’s “the purchase of accounts receivable at a discount.” It is a tried-and-tested funding solution, especially for growing businesses, and has been for centuries. 

In fact, the principle of factoring can be traced back to the Mesopotamian Era (around the 18th Century BC). The sixth Babylonian King, Hammurabi, set down a code of laws known as the Code of Hammurabi, a part of which laid out rules for merchants who wanted to use factoring as a form of funding. The process evolved throughout history, even being used by merchants in ancient Rome that used agents known as “factors” to secure trade credits. 

Eventually, in the 1300s, the modern form of invoice factoring began to take shape. Throughout Europe, various historical events gave rise to the use of factoring among different merchant groups. During the 1300s and 1400s, Jews fleeing persecution in Spain sought refuge in Italy and, restricted from owning land, became involved in local grain commerce. They started charging a fee for the use of cash and eventually began offering high-risk loans to farmers against the crops in their fields. This service evolved to include advancing money for the delivery and payment of grain exported overseas. In England, clothing merchants also began utilizing factoring as a means of financing.

Factoring has evolved into a fast-paced and sophisticated B2B financial service, but the core idea remains the same: a third party purchases a company’s invoices at a discount to enable the company to operate and raise capital for growth. The factoring firm advances most of the invoice value, collects payment on the company’s behalf, and then repays the balance once the customer has paid in full, minus a small fee. 

Some factoring firms also provide added back-office services such as handling invoicing and collections and even offer industry-specific benefits. To qualify, you don’t need extensive collateral or assets, a high credit score, or a long business history. Factoring professionals evaluate applicants based on their customers’ creditworthiness. Unlike bank loans, funds from factoring are unrestricted and grow with invoices, and most companies provide access to funds within 24-48 hours.

If you need a quick injection of working capital for your business, investigating factoring may be your best option. Smaller, less-established businesses can qualify, the turnaround time is substantially faster than a bank loan, and it does not negatively affect your credit rating like a loan would. 

There are four main components that make up the invoice factoring process:

The invoice factoring process involves selling control of your accounts receivable to the factor, either in part or in full, and it works like this:

Factoring is one of the easiest forms of funding to qualify for, which is why so many businesses from a variety of industries rely so heavily on it. From start-ups to fully established corporations, any business that sells a product or service to customers but usually waits for 30, 60, or 90 days (or more) for their customers to pay them can benefit from invoice factoring. 

Businesses in the following industries improve their cash flow with invoice factoring every day:

How do you know if your business needs invoice factoring? There are a few factors to consider, but first, think about these questions:

If you answered “yes” to any of these questions, invoice factoring could go a long way in solving your cash flow problems. Instead of waiting for late-paying customers to finally pay you, you get paid in advance – giving you the cash flow and financial freedom you need to cover your expenses, hire new staff, expand your business, and even start saving.

In short, factoring can be extremely beneficial. It supports your business growth, protects your business from debt, helps you improve your financial planning, saves you time and money, and keeps your collateral safe.

Traditionally, factoring was a funding option utilized mainly by large corporations. But today, an increasing number of small and medium-sized enterprises are opting for factoring companies and their tailored cash flow solutions. Converting invoices into quick cash is a favored method of financing for many companies.

The difference between invoice factoring and a bank loan is often a topic of interest. Those unfamiliar with the concept of factoring may be concerned about the costs or hidden terms of the service; however, when compared to a bank loan, there are a number of ways in which factoring comes out on top. Factoring is not the same as borrowing from a bank. The application process is a lot faster (and less stringent), and it’s debt-free. You are simply getting an advance on money already owed to you instead of taking out a loan based on uncertain future earnings.

Factoring has several advantages over bank loans, such as:

Here are a few instances where invoice factoring is the preferred option compared to a bank loan:

We already know that factoring has been used for thousands of years, but the concept of invoice factoring for small businesses has really gained popularity over the past two or three decades. Despite the fact that a growing number of industries and businesses are taking advantage of this service, there are still a few misconceptions.

While we’re on the subject of how factoring companies are better than traditional lenders, we should debunk some common myths that hold people back from trying invoice factoring.

Contrary to popular belief, many thriving businesses use factoring to improve their cash flow, not just those in financial trouble. They choose to receive payment for completed work sooner rather than later, using the funds that have been sitting in their accounts receivable for months. This appeals to all business owners, not just those facing financial challenges.

Factoring companies are different from traditional lenders, such as merchant cash advance (MCA) providers, payday loan companies, or banks. They do not lend money that needs to be repaid. Instead, they provide prompt payment for work already completed, allowing you to receive payment for what you are owed without incurring debt.

Factoring companies provide you with payment for what you are owed and assist with collections, but they offer much more than just collection services. Factoring clients can also access valuable services such as invoice preparation and processing, payroll management for staffing agencies, and fuel cards with discounts for trucking companies. It is also important to note that, unlike a collections agency, factoring companies do not chase delinquent accounts. While they will attempt to collect past-due invoices from your customers, their entire service revolves around obtaining payments from your creditworthy clients. If you have delinquent clients with invoices that are more than 90 days overdue, it is likely that those invoices will not be approved for factoring.

While collections agencies have a reputation for harsh collection practices, factoring companies are completely different, and your clients will likely already be familiar with the concept. When you start your factoring journey, the factor will have a friendly and professional team that will contact your clients and notify them that they will be handling the collections, and all their collections efforts will be conducted with the same level of professionalism and friendliness. Plus, you can even improve your customer relationships because, with a strong business cash flow thanks to factoring, you will be able to extend selected clients more flexible payment terms. For example, if you are competing with another company for someone’s business, you could offer better payment terms to the customer in order to seal the deal. 

When you use invoice factoring, you will be required to sign a factoring agreement – a legally binding contract between your business and the factor that outlines the terms and conditions of the factoring arrangement. This includes the volume of invoices to be factored, the advance rate, factoring fees, payment terms, and more. It is very important to read through the agreement thoroughly and ensure you understand it completely before you sign. 

Carefully reviewing the factoring agreement will ensure that you understand your obligations (as well as those of the factoring company), avoid misunderstandings, and identify any hidden fees. Plus, the agreement will outline any provisions that your company is expected to comply with, such as reporting requirements, maintaining accurate records, or confidentiality provisions. In short, by carefully reviewing the factoring agreement, you can ensure that your business’s interests are protected and that the factoring arrangement is successful.

When it comes to determining how much invoice factoring will cost, there are three main points to consider.

The majority of factoring companies will use a tiered rate structure for their services, which allows them to link the cost of financing to the period of time the invoices are outstanding. 

With a tiered rate structure, the cost of financing will increase the longer the invoices remain unpaid. 

With a flat rate structure, the factoring rates are represented as a fixed fee, regardless of how long it takes for your customers to pay their invoices. 

This is usually the preferred method for businesses, but you may need to do some research into which factoring companies will offer this rate structure. Factoring companies may use flat rates when your customers have predictable payment schedules.

The factoring rate is determined by several factors, including the creditworthiness of your clients, the industry your business operates in, the volume of invoices, and the length of the factoring agreement. The risk assessment made by the factoring company is a key factor in determining the factoring rate because it impacts the advance and reserve rates you can expect.

Each factor will evaluate risk differently, with some being more open to specific factors than others. Generally speaking, the three main points a factoring company will look at when determining risk include:

When we look at the two types of factoring, we are referring to who will assume the risk if a customer doesn’t pay what they owe.

The most common type of factoring is a recourse agreement, but there are companies that offer both options to their clients. Some may even offer a modified version of recourse factoring to make their services more attractive.

This is by far the most common type of factoring and basically means that your company will need to buy back any invoices that the factoring company is unable to collect payment on. In this situation, the liability for non-payment is on your business, which is why it is the most common service option offered by factoring companies.

The factor is required to make every effort to collect payment from your customer on your behalf; however, if they are unsuccessful, you will need to repay the funds that are currently owed and attempt to collect the customer payment yourself. If you are unable to collect from your customers, you must accept the loss.

It will be specified in the factoring agreement how many days after the due date for payment you must refund the advance. Regardless of whether you are required to repay the advance or not, you will still be held liable for the factoring fee and any interest. Still, recourse factoring is typically less expensive than non-recourse factoring and may have fewer requirements regarding the small business’s customers and systems.

Non-recourse factoring agreements are less common because the risk of non-payment is assumed by the factoring company. So, if your customers default, the factor will not require you to pay them back. 

However, it is important to note that non-recourse factoring does not protect your business from all risks and usually comes with strict conditions such as credit limits, concentration restrictions, and other criteria. In most cases, the factoring company will only assume the risk in very specific circumstances, for example, if your debtor declares bankruptcy. Plus, if your debtors have bad credit histories, their invoices may not even be eligible for non-recourse factoring. 

Non-recourse factoring agreements typically include a higher (often much higher) factoring fee, so to determine whether the cost is worth it, you will need to clearly understand the stipulations and conditions of your factoring agreement.

Modified recourse factoring combines elements of both recourse and non-recourse factoring. With this option, the factor will have credit insurance/ receivables insurance in place and will therefore be able to offer you protection if your debtors are unable to pay their invoices due to bankruptcy. However, the factoring company usually only accepts the risk up to a certain point. For example, the factor may have a 60-day deadline for your client filing bankruptcy. So, if your customer files for bankruptcy within 60 days of the invoice due date, the factor will assume the risk; however, if they file for bankruptcy after the deadline, then the risk is on you, and you will have to repay your advance to the factoring company. 

Again, the specifics will all depend on the factoring company you choose. With some factoring companies, if your customer refuses to pay for another reason, like a service or quality issue, then you will either be held liable for the invoice, or the factoring company may give you the option to exchange the invoice for another one of the same value.

Growing a business is not an easy task and is bound to have its ups and downs. As your company expands, new challenges arise, such as increased inventory and payroll costs. To sustain your business growth, you often need to spend money to make it. This is why there is no shame in utilizing financing options, like factoring, to give you the extra support you need to navigate your growth challenges.

Whether you’re looking for a financial solution to help you manage your cash flow, increase your working capital, or simply reduce the stress of your accounts receivables processes, choosing the right factoring company goes a long way in the overall success of the arrangement. Here are 6 points to consider when choosing a factoring company.

Not all factoring companies are created equal. Some specialize in different industries to offer a more customized service, while others don’t limit their services by industry to cater to a wider audience. Some will offer higher fees with longer repayment terms, while others will offer the converse. All the considerations, from the factoring rates to the advances and contract length, will differ depending on the company you choose. To ensure you get the best partnership, it’s crucial to ask the right questions and do your due diligence. Here are 6 questions you should ask before settling on a factoring company.

Small and medium-sized businesses need financing options that can grow as they do. This means that as your client base grows, your line of credit needs to be able to expand to meet the growing demand. This is why choosing an established factoring company is so important. Unlike a traditional loan with a fixed limit, factoring is known for being a flexible financing option.

A stable cash flow is necessary for making crucial purchases for your business, such as equipment, vehicles, or other capital investments. Factoring helps to keep your cash flow positive by freeing up funds that would otherwise be tied up in aging accounts receivable. This is especially important for small and medium-sized businesses.

In today’s business world, customers often take advantage when it comes to payment terms, stretching their payment due dates to 60, 75, or even 90 days. This can be a challenge for companies with fixed expenses. Factoring provides a solution by converting the money tied up in your AR processes into fast cash, allowing you to take on business without having to worry about the potential customer’s payment terms.

This overview of invoice factoring and how it works is a great starting point in figuring out if this service would be a good fit for your business. If you’re ready to take the next step in finding the right debt-free financing solution to help improve your cash flow, request a factoring rate quote today, and we will connect you with a reputable and experienced factoring company. Our respected factors specialize in your industry and will be able to answer any questions you have and help you get on the path to sustaining and growing your business as soon as possible. Again, if you’re having trouble finding the right factoring company, we will help you explore industry-specific factoring companies from throughout Canada that can serve your business needs. Start working towards a brighter financial future today!