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 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. 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 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?
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 good 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.
What does a factoring company do?
Factoring is a centuries-old debtor-financing practice that enables companies to enhance their cash flow and expand their business. 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.
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. Business owners in the following sample of industries
commonly partner with factoring companies for their working capital needs:
- 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 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.
How can you benefit from invoice factoring?
Improve 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 who 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, you will receive your advance promptly.
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.
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.
Take advantage of supplier 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.
Approval without strong financial history
Factoring companies focus on the payment histories and credit records of your customers – not your financial history. Even if you have been turned down for loans in the past for bankruptcy or lack of a strong credit score or collateral, factoring companies provide 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, you can rest assured that professionally trained collectors are ensuring that any obstacles to payment, such as missing paperwork, are resolved. 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 paying for old business.
Ability to work for larger customers and those with extended payment terms
If you are turn down larger contracts because you do 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, and 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 to Expect in a Factoring Agreement?
- 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.
Other Types of Factoring Contracts
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 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.