What Invoice Factoring Is and How It Works?


Invoice factoring is a type of accounts receivable financing that converts outstanding invoices due within 90 days into immediate cash for your small business. The factoring company will typically pay you in two installments for your invoice: an advance of 80 percent to 85 percent of your invoice and the remaining 20 percent (minus fees) after the invoice is paid.

Though similar, invoice factoring is not the same thing as invoice financing (or accounts receivable financing), although the terms are often used interchangeably. Invoice financing is more streamlined, easier to use, and doesn’t require the assignment of invoices like factoring does.

Invoice factoring is typically a solution for short-term cash flow problems. It is frequently used as a way for businesses to simplify their cash flow conversion. Invoice factoring is not traditionally the type of financing that is used for big capital investments.

How Invoice Factoring Works in 5 Steps

You Invoice Your Customer

Once you have provided products or services to your B2B or B2G customer, you issue an invoice for them to pay you. To qualify for factoring, these invoices must be payable within 90 days.

You Sell & Assign the Invoice to a Factor

You find a factor you want to work with, go through the application process, and sell them all of your outstanding invoices. When you submit an invoice to a factor, a few things will happen.

First, the factor will determine if you meet eligibility criteria to receive financing. They will also conduct due diligence on the customers you’re invoicing to see if they are good credit risks. If the factor decides to approve your business based on that research, you and the factor will sign a financing agreement. The agreement will set an initial maximum dollar amount that you can borrow, which is the maximum factored amount outstanding at any given time.

The Factor Pays You an Advance

The factor gives you an initial advance called an advance rate. The amount of your advance depends on the size of your transaction, your industry, and other risk parameters.

At this point, the factor may also send out a “notice of assignment” to the clients you have chosen to factor, or they may ask you to do so. The notice of assignment states that your company has assigned the factor as the entity to receive future payments for invoices you issue them. All payments will go to a lockbox account (like a designated account for the factored invoices to be paid), which is set up by the factor.

Some industries are more accustomed to invoice factoring than others. Trucking and shipping companies commonly use freight factoring, and staffing companies and recruiting agencies use staffing factoring. In industries where factoring is common, telling a client you’ve assigned their invoice might not be a problem. If factoring isn’t common in your industry, you might benefit from invoice financing, which doesn’t require invoice assignments.

Your Client Pays the Factor

Your client will pay the factor within 90 days according to the terms of the invoice. The factor will typically handle the collection on all the invoices you assign to them. Typically, the factor tries to follow your history of collection techniques, unless the client is past due. This means there is generally no negative impact to your customers.

The Factor Forwards You the Remaining Balance (Minus Fees)

After receiving payment from your client, the factor will give you the remaining balance of the invoice, called the reserve amount, minus their fees.

Who Invoice Factoring Is Right For

Invoice factoring is right for businesses needing a consistent cash flow solution. If you choose invoice factoring, you need to be prepared to bring a partner into your business on your accounts receivable management and collections process. This includes a willingness to give up some customer control, as your factor will likely have contact with your customers.

Invoice Factoring Costs & Qualifications

Invoice factoring is a good working capital solution for businesses of many different ages and sizes, as long as you have qualifying invoices. Many factoring companies will even work with you if you’re a startup. The typical fees and overall costs can be tricky to understand, but all typically fall into the ranges in the table below.

How to Qualify for Invoice Factoring

Qualifying for invoice factoring is easier than qualifying for long-term financing. While credit scores, annual revenues, and profitability can be significant hurdles for other types of financing, those are less often issues with invoice factoring.

Most factors care about three primary things:

  1. You must invoice business (B2B) or government (B2G) customers. Your customers must have good credit scores and they must be established businesses. The factor will need to feel comfortable that your customers are likely to pay off your invoice.
  2. The invoices must be due and payable within 90 days and unencumbered by other loans. (For example, you can’t have another short-term loan outstanding where the same invoice is pledged as collateral.)
  3. Your business should not have a history of serious tax or legal problems.

Invoice Factoring Costs

The base cost (without additional fees) of an invoice factor depends on two things:

  1. Discount Rate (or Factor Rate): The discount rate is the primary cost of borrowing money from the factor and is typically charged on a weekly or monthly basis. The industry range is 0.5 percent to 5 percent of the invoice value per month. Many factors have a tiered system for their discount rates, so the more you factor in a month, the lower your discount rate is.
  2. Length of Factoring Period (time it takes your customer to pay): Discount rates are charged at regular intervals (usually weekly or monthly), so the length of time it takes for the customer to pay your invoice will determine your cost.

Some factors charge additional fees other than the discount rate. Some “hidden fees” to watch out for are:

  • Origination Fees: Upfront costs associated with initiating a new factoring relationship and opening your account; these could be up to $1,000.
  • Incremental Fee: If your discount rate is a flat fee, then you may be charged an incremental fee to increase the total discount paid to the factor as an invoice ages. This fee can range from 0.35 percent to 1 percent.
  • Service Fee or Lockbox Fee: This is a flat fee that your factor may charge you to keep a lockbox (like a designated account for the factored invoices to be paid) open for your customers to pay their invoices to. It can range from $50 to $500 per month.
  • Collection or Overdue Fees: Your factor may charge you for their efforts required in collecting past due payments from your customers. Some will even charge you a flat fee for any payment that becomes past due. These fees vary greatly by factor and could be nothing to a few thousand dollars.
  • Unused Line Fee: Charged for the unused portion of a factoring facility for a given month. It is typically stated as a percentage and charged on a monthly basis. It can range from 0.15 percent to 0.5 percent.
  • Monthly Minimum Volume Fee: In the event you don’t generate a certain level of fees for your factor in a given month, they may charge you a fee up to $1,000.
  • Renewal Fee: An annual fee applied after every full year the line is open. Could be up to 1 percent of the factoring facility size.
  • ACH Transaction Fee: A fee of $5 to $30 that is charged for every advance or disbursement issued from the factor to you.
  • Wire Fee: Charged if you request to receive a wire instead of an ACH, which is the preferred method of payment by most factors. The factor passes on the charge from their bank to you, typically $15 to $50.
  • Credit Check Fees: These are small in comparison to the other fees, but your factor may pass the cost on to you for any credit checks they need on you or your customers.

Because of the amount of different fees that you could be charged, it’s important to:

  1. Ask each factor company you are interested in working with for a breakdown of their fees.
  2. Carefully review your factoring contract (with the assistance of an attorney, if needed).
  3. Compare different factoring proposals before signing on the dotted line.

How to Choose the Right Invoice Factoring Company

There are over 700 factoring companies in the United States. There is tremendous variety in the services they offer, how they conduct their business, and what they charge. Do your research carefully so that you don’t end up with unintended costs or consequences. Here are the things to consider when shopping around:

Time to Get Funding

The speed of getting money may matter to you more than anything else if you’re depending on it to make payroll or buy something essential for your business.

The time frame for you to be funded using invoice factoring is comparable to getting a short-term loan, but it varies by factor. You can generally qualify within two to seven days, and be funded in one to three business days after that.

Recourse vs. Non-Recourse Factoring

One of the most important concepts to understand when considering invoice factoring is recourse factoring vs. non-recourse factoring. This tells you what happens if your customers don’t pay the invoice on time.

Recourse factoring means that the factor has the right to collect payment from you if your customer doesn’t pay the invoice within a reasonable time after its due date. This can be a problem if you’ve already spent the money you received from the factor. This is why you should only factor invoices to customers who reliably pay on time. Fees can continue to accrue until the factor is paid, often creating a new cash flow problem.

Non-recourse factoring is when the factor accepts the risk that the customer won’t pay. In this case, even if your customer doesn’t pay the invoice on time, your business won’t be on the hook for it.

Some firms advertise “non-recourse” factoring, but on the contract, they list several reasons why an invoice can be exempt from no recourse. Other factors will offer partial recourse agreements. Small businesses should tread cautiously and read their entire contract carefully to make sure what they will and won’t be responsible for if their clients don’t pay the invoice or pay the invoice late.

Industry Familiarity

Factoring is an area in which industry familiarity matters. The industry you and your customers are in can affect your terms and cost. Some factors specialize in providing financing to specific industries. Conversely, some factors won’t provide financing to certain types of industries.

Pros of Invoice Factoring

The pros of invoice factoring include:

  • No Credit Score Requirement: With invoice factoring, your customer’s creditworthiness is more important than yours. This means you’re able to get financing even if you have poor credit.
  • You Get to Work with AR Experts: A potential upside to invoice factoring is the ability to develop relationships with AR management experts. Since this is what your invoice factoring company does on a daily basis, it likely has really good accounts receivable management techniques. You get the benefit of their expertise.
  • Quick Source of Cash: Invoice factoring provides a quick source of cash. You can typically get approved within two to seven days and funded in one to three days. There are, however, other fast business loans you could consider. It’s always good to weigh your options.

Invoice Factoring Frequently Asked Questions (FAQs)

The following are some of the most frequently asked questions about invoice factoring:

Do I Have to Give up Customer Control with Invoice Financing?

With invoice factoring, you typically need to give up some of your customer control to your invoice factoring provider. This is not typically the case with accounts receivable financing. With invoice financing, your relationship with your customers typically remains unchanged. You’ll continue to bill and collect your invoices just like normal.

Does Invoice Financing Work for Companies with Credit Problems?

While most invoice financing companies will take your credit into consideration to some extent, it’s typically less of a concern than with other types of working capital loans. If a credit score is required, it will typically be low (530+ for BlueVine), or there may be no minimum credit score requirement (like with Fundbox).

How Do Businesses Qualify for Invoice Factoring?

Unlike most short-term financing, which is based on the creditworthiness of your business, qualifying for invoice factoring has little to do with you. Since repayment is based on your customers paying their invoices, the ability of your customers to repay is typically the most important. The creditworthiness of your customers matters more than your credit.

What Does a Factoring Company Do if My Customers Don’t Pay Their Invoices?

What happens in the event your customers don’t pay their invoices depends on the arrangement you’ve made with your invoice factoring company. With non-recourse factoring, the factoring company is responsible if invoices aren’t paid because your customer filed for bankruptcy or is otherwise insolvent. It’s important to read your contract closely to understand your responsibilities.

Will I Be Required to Factor All of My Invoices?

The arrangement you’ve made with your invoice factoring company determines if you have to factor all your invoices. With spot factoring, you get to pick and choose the invoices you sell to the factor. Contract factoring, which is more common, requires a minimum monthly volume or sets requirements on which invoices you have to sell.

Bottom Line

Factoring can seem a little more complicated than getting a loan from a bank. However, what makes factoring complicated is also what makes it appealing. You can borrow money based on your unpaid customer invoices to meet your immediate cash flow needs. If your clients pay in a timely manner, the cost of factoring is more affordable than many other short-term business loan alternatives.

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