For thousands of businesses across the country and around the world, invoice factoring is an excellent tool for improving cash flow without incurring debt. Factoring companies ease business owners’ financial pressures by purchasing their unpaid invoices and advancing them what they are owed. Getting paid upfront speeds up cash flow and gives owners a business advantage and the working capital to grow their company.
Ready to learn more? Here are some common questions and answers about the factoring process:
What is factoring?
The definition of factoring is the process whereby a third party buys a company’s invoices at a discount for that company to raise capital. Factoring is a form of alternate financing, otherwise known as “accounts receivable financing” that provides businesses with immediate cash for their invoices, without them having to take out a loan or credit card. A third party – the factoring company – buys the business’s invoices and then collects on those invoices on their behalf, in exchange for a percentage of the invoice. Factoring is not the same as a bank loan; you do not accrue debt when you sign a factoring agreement and you do not need collateral to secure the cash advance.
How does factoring work?
The process is a simple advance on work that has been completed. After you have completed a job or delivered a product and prepared an invoice for a creditworthy customer, you forward that invoice to your factoring company and, if applicable, documentation that the product was delivered or the service was finished. Right away you receive between 75% and 100% of the value of the invoice. Once your client has paid the invoice, the factoring company sends you the balance, minus a small factoring fee, which is calculated as a percentage of the invoice.
What is a factoring company?
A factoring company is a financial services company that serves as a third party for buying their clients’ invoices and collecting from clients’ customers in order to pay clients upfront the value of the invoices, minus a factoring fee. Factoring companies are unique financing businesses, very different from banks or other lenders.
Factoring companies provide instant cash flow instead of businesses having to wait 30, 60 or even 90 days for customers to pay for services or goods. A well-established factoring company will have the systems and people in place to provide professional credit and collections services along with efficient accounts receivable and accounts payable staff and account managers to expedite all funds to your business.
Is factoring a new funding solution?
Factoring is a centuries-old debtor-financing practice dating back to ancient times. The concept of getting paid by a third party before a customer pays for a good or service likely started when a business person with financial resources would advance a craftsman or merchant part of his expected earnings for his goods. Through different networks and knowledge of buyers in other lands, the business person would judge the honesty and reliability of the merchant’s buyer and decide if the transaction would be worth the risk of advance payment to the merchant. The business person assumes the risk of possible non-payment and keeps a part of the amount due to the merchant to protect against times when customers don’t pay.
By the Industrial Revolution in the 19th century, factoring arrangements appeared in a number of industries, such as textile production. In the last three or four decades, factoring has become a much more common cash flow solution.
What does a factoring company do?
A factoring company’s main business is advancing funds to clients upon submission of their invoices. In essence, a factoring company buys invoices at a discount and provides upfront payment to clients for products they have shipped or services they have completed. Some factoring companies take care of all the associated back-office administration of invoice preparation and processing as well. Top-tier factoring companies give you access to the cash sitting in your stack of accounts receivable on the same day that you submit your invoices.
Why should you consider factoring?
Consider factoring if you have business customers with payment terms of 30 days or more and you could benefit from improved cash flow. If you need to close the gap between completing a job and getting paid for it, factoring provides fast income for payroll, rent, and other business expenses. If you own a small business or a start-up company, factoring will help you maintain a healthy cash flow. If you have a less than perfect credit score or payment history, then factoring can provide a fast solution to finding working capital.
When should you use a factoring company?
Use a factoring company for all or some of your invoices if your customers take a long time to pay and you are struggling to manage your cash flow while waiting for their checks. You can also choose to use a factoring company if you could use back-office support with credit checks, managing invoices and collecting on invoices. If you have faced financial challenges in the past, such as bankruptcy, tax liens, or low credit scores, factoring offers a reasonable source of working capital because your application for factoring is evaluated on the credit history of your customers, not your company.
How do you choose a factoring company?
Find a factoring company that specializes in your industry. Look for companies with extensive experience in helping thousands of companies maintain a healthy cash flow and grow their business. Search for companies that have the resources for fast funding and value-added benefits for your industry.
Who uses factoring?
Factoring works for companies of all sizes from a variety of industries. Companies that conduct business-to-business sales and issue invoices with payment terms are good candidates for the benefits of factoring. Companies that commonly partner with factoring companies come from a variety of fields that can include – but are not limited to – the following:
- Government contracting
- Temporary and permanent staffing
- Oilfield services
- Wholesale and distribution
- Agriculture and food production
- Janitorial and cleaning services
Who needs factoring?
Factoring is open to any and all businesses, big or small, that are experiencing challenges in paying bills while waiting for customers to pay. Businesses without good credit, deep cash reserves, or significant assets for collateral often need factoring to raise working capital.
How are factoring companies regulated?
Factoring companies are not federally regulated. However, the International Factoring Association (IFA) is a strong professional organization with a clear set of ethics. The association self-regulates and monitors factoring companies to maintain high standards within the industry. When looking for a factoring company, make sure to select one that belongs to the IFA.
Will I need to factor a certain amount?
At leading factoring companies, you can speak with a factoring specialist to see if your volume of invoices per month and average invoice amounts will be appropriate for that company to work with you. Once you are on-boarded, you may not need to factor all your invoices – you will get to choose which ones and when to submit them.
What are the advantages of factoring versus a bank loan?
Unlike a bank loan or line of credit that must be paid back, with factoring you are simply receiving an advance on what you are already owed for completed work. While banks require collateral to guarantee a loan, factoring companies do not require collateral or a personal guarantee. You are not borrowing money; you are expediting payment without waiting weeks or months for customers to pay.
How fast can you receive funding?
At a leading factoring company, you can choose to be paid by wire transfer, direct deposit, check, or other methods, such as fuel advances on a fuel discount card. A wire transfer into your bank account can be received within an hour or two of approval with a direct deposit going into your bank account within 24 hours.
How can you benefit from invoice factoring?
Companies that factor receive a number of benefits from the arrangement, including the following:
- Improved cash flow
Invoice factoring benefits companies that need cash upfront to cover bills while waiting for customers to pay. By speeding up the money coming into the company, the owner can use their cash infusion for improvements in the business that would better increase profitability. For example, companies that use invoice factoring can apply the cash toward buying new equipment, restocking supplies, hiring more employees, and whatever is needed to expand at a much quicker rate.
- Quick access to cash
Bank loans typically require a lengthy application process and you could wait for weeks before receiving a loan or a line of credit. With factoring, you can get access to the cash that is sitting in your accounts receivable within a day or two. As soon as the factoring company determines that your customers are creditworthy and you submit your invoice for the completed work, you will receive your advance promptly.
- Working capital with no extra lines of debt
Many companies want to avoid taking on more debt, especially for day-to-day operations. When you borrow from a bank or an online lender, you add another loan that must be paid off out of unknown future income. Factoring is not a loan; you incur no debt for an advance on what you’ve already earned.
- Flexible funding arrangements
Top-tier factoring companies offer flexible factoring terms that can be lowered when your sales volume increases and you are factoring more invoices. Some factoring companies let you choose which invoices or which customers to factor.
- Supplier and volume discounts
Having cash in hand gives you negotiating power. When you have cash in hand, you can benefit from early payment or volume discounts from suppliers.
- Easy and fast approval for funding
When taking on new clients, factoring companies focus on the payment histories and credit records of a potential client’s customers – not their own financial history. Even if you have been turned down for loans in the past for bankruptcy, low credit score, limited previous business experience, or lack of collateral, you can receive funds for operations and growth from a factoring company. Factoring provides an excellent alternative to bank financing.
- Professional collections services
When you partner with a leading factoring company, their collections team will be following up on your outstanding invoices for you. Instead of hiring someone to handle outstanding payments, professionally trained collectors will ensuring that any obstacles to payment, such as missing paperwork, are resolved and money is sent promptly on invoices. The collections team helps factoring clients by handling all the administration involved with receiving and processing payments. Not only will this free up your time and resources, but it ensures a helpful separation between asking customers for new business and asking them for to pay for old business.
- Increased ability to work for larger customers and those with extended payment terms
If you have had to turn down larger contracts because you did not have the resources to cover the costs of the job before your customer pays you, then factoring gives you the cash flow to take on that customer’s jobs. You can also work with customers with long payment terms and no longer have to limit yourself to jobs that who pay quickly.
- No limits on funds
The money you receive from the factoring company can grow as your receivables grow. The only limit is the need to work with creditworthy customers. Your funds also are not subject to spending restrictions. With a business loan, your spending will often be monitored and you are required to use the money that you borrowed for pre-approved purposes. With factoring, you are free to spend the money you have earned as you see fit.
- Value-added benefits and services
Some factoring companies offer a range of services and benefits, such as free credit reports on customers, free direct deposits and wire transfers. Companies that specialize in the trucking sector, for example, may offer discount fuel cards, equipment financing and fuel advances.
What is a factoring agreement?
When you decide to sign up for factoring services with a factoring company, you will sign a factoring agreement or factoring contract that outlines what you and your factoring company can expect. A factoring agreement is the document you sign, together with your factoring company, outlining the expectations and requirements of the transaction. Agreement specifics vary, but factoring agreements basically outline the process, each party’s responsibilities, the length of the agreement, and the fees.
The factoring agreement or contract will include a breakdown of the costs associated with factoring. The discount rate is what clients are charged to receive their funds in advance of the customer payment. This factoring rate is expressed in a percentage of the original amount of the invoice. Advance rates vary, depending on the type of industry involved and the value of the transaction and could range from 70% to 100%.
What you will find is that the factoring rates on these agreements will depend on many variables, including the volume and dollar amount of the invoices you expect to factor. The rates will also be influenced by the credit records of your customers — not by your company’s credit history. Before granting loans, banks scrutinize your payment history, financial stability, assets and collateral, but factoring companies want to know about your customers’ creditworthiness.
What can you expect in a factoring agreement?
A typical factoring agreement will include the following components:
- A statement that the client (the owner or controller of the company wanting to sell their accounts receivable in exchange for immediate payment) confirms they will “sell, transfer, convey, and assign” selected invoices to the factoring firm
- A requirement that the client provides accurate and true financial information at all times, including accurate and true written invoices, purchase orders, or other such documents supporting the delivery of products to customers or the satisfactory performance of services
- A description of the Notice of Assignment process that notifies customers that they will send in their payments to the factoring firm rather than to the client
- A commitment for the factoring firm to provide continually updated reports on the invoices that they have purchased, the payments sent to clients, the payments received, and other information
- A description of steps taken to secure payment of any indebtedness that is due to the factoring firm in the event of default or insolvency
- A time limit for the agreement (can typically be a year)
- A fee schedule that specifies the factoring percentage rate (the amount that the factoring firm retains on an invoice to cover administrative and other costs) and the advance rate
- Factoring agreements can be written for just about any business that works with invoices. Agreements will vary based on the exact types of factoring services rendered.
What are some other types of factoring arrangements?
Unlike regular invoice factoring where you are dealing with batches of random customers, reverse factoring brings individual large accounts into the picture. This allows the factoring firm to ensure that they will be paid and allows your business to receive up to 100% of the total sum due, minus fees and charges. These factoring agreements differ in that you do not give up a percentage of the invoice total but have to pay the factoring firm a specific interest rate just as you would pay on a bank loan.
- Invoice Selling
Invoice factoring is different from selling invoices outright because if the invoices are not paid within a certain time, usually 90 days, the invoice factoring client is liable for the unpaid amount.
Invoice discounting is a process in which a business uses its unpaid invoices as collateral for a loan from a non-traditional institution. The business pays only an interest rate on the loan while collecting the full amount of the invoices. The rates for discounting are usually considerably higher than a typical bank loan as well as the rate you would pay through simply factoring your invoices at a discount.
For professional advice and personalized factoring service, and to learn more about what is factoring and what it can provide to your business, you can get a complimentary factoring assessment today.