Invoice Factoring, also known as accounts receivable financing, is a financial service wherein a business sells its invoices to a third-party (known as a factor). This allows the business to immediately turn their outstanding invoices into cash flow weeks before payment is due. The factor then collects the invoice payment from the business’s customer, completing the factoring cycle.
Invoice factoring is utilized by most business-to business industries. While invoice factoring can benefit most businesses at any stage of their lives, there are certain types of businesses which benefit in particular:
- Any business which operates on terms of Net-30 or longer with their customers is a business that can benefit from factoring their invoices.
- New, un-established businesses find invoice factoring to be particularly useful. Since traditional bank finance is dependent upon longer earnings histories and collateral that a new business will generally lack, those sources of funding are usually not available. Invoice factoring, on the other hand, is only interested in the quality of the invoices being factored, regardless of the age of the company.
- Businesses who are experiencing fast growth can be greatly helped by a factoring program. Even once companies can qualify for bank financing, that financing is often too rigid to quickly respond to large upswings in growth and can stifle a company’s ability to take opportunities when they come. Invoice factoring is much more flexible than traditional bank finance – funding levels can increase rapidly as growth increases.
Payment speed varies from factoring company to factoring company, depending on their approval and funding process. Most factoring companies pay within 24-72 hours of an invoice being approved as good by a business’s customer.
A factoring company is primarily concerned with the quality of invoices it factors. That means that they want to make sure that the customer who owes the money is likely to pay it. Generally, a factoring company will attempt to receive a confirmation from a business’s customer that the invoice is accepted as good for payment and that the invoice amount is accurate.
Factoring fees differ between factoring companies, but are generally based around similar methodologies. Things that determine a factoring rate can include a risk profile based on industry, amount of money advanced per month, the payment term of the factored invoice, and others.
There are two types of factoring rates; flat rates and tiered rates. Flat rates are generally more expensive if an invoice is paid quickly, but will not go up if payment is slow. Tiered rates start cheaper than flat rates, but never stop increasing as time goes on, making them a more expensive option when invoice payments are slower. Each business must determine for themselves which type of rate best suits them.
As with many questions related to invoice factoring, the answer differs from factoring company to factoring company. However, since additional fees can sometimes be a substantial portion of the cost of factoring, it is important for a business owner to figure out what additional fees (if any) they are being charged. Some factoring companies offer a low up-front rate but fill their factoring program with fees for core services.
Types of fees include per-invoice fees, ACH fees, set-up fees, invoice processing fees, same-day payment fees, monthly minimum fees, early termination fees, serviced account fees, and more.
Factoring companies differ on the length of their contracts, but most contract terms are between 6-12 months. Some factors offer shorter terms, like month-to-month. In addition, factoring companies often pair their contract terms with termination fees, sometimes potentially thousands of dollars worth. It is always best that a business interested in factoring get all of this information up front, as the answer will have a large impact on their business.