Invoice Factoring Loans | Receivables Factoring | Business Loans

Factoring

Quick Overview

The business owner sells some or all of the Account Receivable at a discount
Two types of factoring: recourse and non-recourse factoring
The factor collects the invoice from the customer
Available online and from some traditional lenders

By Bradley Harris | Last Updated: September 5, 2024

Although factoring has been around for thousands of years, its popularity has risen recently, with more than $3 trillion in accounts receivable being factored in 2013 alone, a large increase from a few years ago.

What is an Invoice Factoring?

Invoice Factoring is technically not a loan and is sometimes referred to as a “lockbox” at banks that offer the service. It’s the preferred method of financing in the textile industry and can be useful for any businesses that don’t have other assets to offer as collateral and need capital quickly.

A “factor” is a third party that purchases part or all of a company’s accounts receivables in exchange for a percentage of the invoice. The “factor” then owns the outstanding invoices and collects them from the customers. The factor earns a profit from the difference between the discounted rate negotiated to buy the account receivables, and the full invoice amount collected from the customer.

What is an Invoice Factoring Company?

An invoice factoring company, or factor, is an entity that serves as a finance partner that essentially advances cash against owed receivables. Invoice factoring companies are distinct from traditional lenders or banks and have a different application process than the more commonly sought lenders. That said, invoice factoring companies are perfectly legal and have been around in some form or another for a long time.

How Invoice Factoring Works?

Interested business owners can contact a factor (there are several independent factoring companies, searchable via the Commercial Finance Association) or any bank that offers the service. From there, you can research a variety of factors and choose the one that is the best fit for your situation.

Most factors target specific businesses based on their annual revenues and the volume of invoices they produce each year. Some factors even specialize in particular industries. Once you choose a factor, they will review your client base to determine the creditworthiness of your average client, including a review of your previous shipment and collection information. If a client’s account is deemed acceptable, the factor will negotiate to buy your invoices for between 85% and 95% of the face amount, depending on the factoring agreement and average client creditworthiness.

Fees often range from 2% to 4.5% of the total invoice amount for every 30 days the invoice is unpaid after factoring. Payments are generally advanced within one to three days, and the factor will then collect the total value of the invoices from the company’s clients. Once the invoice is paid, the factor will pay the business the balance of the invoice minus the agreed-upon fees. The fees in a factoring agreement are based on variables such as the credit quality of the client base and the size of the invoices. These fees are negotiable in the initial contract with the factor and can change.

*Note: Invoice payments must be paid to the factor, and the factor has a legal right to communicate directly with a selling company’s clients to ask for payment.

Invoice Factoring Example

Invoice factoring is straightforward once a company gets familiar with the process. One example of invoice factoring might be if a restaurant supply store needs $20,000 in short order to purchase new equipment for its client’s restaurant kitchen and can’t wait for the $20,000 in outstanding bills that it’s owed in order to front the money for a purchase. It might pursue invoice factoring so it can access those needed funds in liquid form. Then, when the bills get paid, they can pay back the funder.

Why is Invoice Factoring Important?

Invoice factoring is a great option for businesses to get a fast cash infusion. Rather than relying on clients to pay their outstanding invoices more quickly, small business invoice factoring, also known as accounts receivable financing, can be a useful way to get the cash you need when you need it.

Why is Invoice Factoring Popular Among Business Owners?

Invoice factoring has become popular among business owners, and particularly small and medium-sized brands, because the invoice factoring option enables them to access cash quickly. Invoice factoring, or receivables factoring, allows companies to access capital against receivables owed without having to wait for clients to pay. In instances when a company, including a smaller brand or one that hasn’t been in business for very long, may be growing quickly and need capital to ensure a smooth process, invoice factoring can be the best solution.

How Invoice Factoring Can Be Used for Cash Flow?

Invoice factoring can be a useful avenue to increase cash flow. Smaller brands that may not have a lot of savings or liquid capital at any given time can find invoice factoring a convenient and helpful option to get cash quickly. Particularly if customers are slow to pay outstanding balances or if you need a cash infusion to plug a gap in cashflow or help your business scale, invoice factoring can help provide that cashflow that’s needed.

Short History of Invoice Factoring for Small Businesses

There is nothing new about invoice factoring. In fact, small companies have been using forms of invoice factoring for centuries, even millennia, even the earliest examples date back to the Roman Empire as far back as 27 BC. Merchants from the Middle Ages through to the 20th Century have relied on invoice factoring, from traders lending money against anticipated goods sold, to states advancing capital to purchase goods overseas that would not materialize for many weeks or months. In other words, invoice factoring is as old as commerce itself, a tried and true method for conducting business.

The Two Types of Factoring

There are two main varieties of factoring agreements: recourse factoring and non-recourse factoring.

Recourse factoring: A company sells its accounts receivables to a factor with the understanding they will pay the factor for any invoices the factor is unable to collect. This is the most common form of factoring in the United States.
Non-recourse factoring: The factor assumes all the risk for uncollected invoices. If an invoice goes unpaid, the business is not liable. Since this agreement carries an increased risk for the factor, the transaction fee is usually as much as one percent higher than a recourse factoring agreement. It can also sometimes take longer depending upon the creditworthiness of the customers being invoiced.

Is invoice Factoring Right for My Business?

Invoice Factoring is a valid option for businesses in many industries. It’s often used in the manufacturing sector because of the traditionally long cycle for producing consumer goods that are distributed through multiple channels before ultimately reaching consumers. It’s also used in many other industries involving business-to-business sales.

Pros of Invoice Factoring:

Factoring can be a good option for small businesses looking for quick access to capital without going into debt, giving up equity, or encumbering capital assets.
Factors provide immediate working capital so your company can continue to produce and ship without interruption while giving clients acceptable terms to pay.

Cons of Invoice Factoring:

Factoring can be expensive when compared to the cost of traditional lines of credit—though it is less costly than missing sales or letting growth overwhelm the business.
The business owner must be willing to allow the factor to collect the invoice directly from the customer.

Should you consider Invoice Factoring?

Depending on the industry and the nature of the business, factoring may be a viable option for many small businesses in need of capital—and in some industries is standard practice. The ability factoring provides to access capital quickly makes it a viable option for many small business owners.

How to Qualify for Receivable Factoring Loans?

You will need to complete an application and provide information about your business and finances. Most critically, invoice factoring companies that are considering lending you money will look at your customers. Since invoice factoring is essentially a cash advance against receivables due, the reliability of your customers to pay their outstanding invoices that you’ve issued will be central to determining whether you might qualify for an invoice factoring loan. If your customers have a track record, for instance, of not paying their bills or they are at risk of going belly-up, an invoice factoring lender, or factor, might not want to take on that risk by lending you money.

To Sum Up

Like any other business financing option, it’s important to do your homework to ensure this is a good option for you and your business. Make sure you completely understand the terms of any factoring agreement before you sign on the dotted line.

Many online lenders use technology to evaluate businesses differently from traditional lenders. For example, online lenders may access a business’ transactions and cash flow via their bank account’s website or examine other digital data points to analyze a business.