Businesses often face cash flow challenges when customers take 30 to 90 days to pay invoices. During this waiting period, companies must still pay employees, suppliers, and other expenses, creating financial strain. This strain can hinder growth and disrupt operations, particularly for large orders or seasonal businesses. One way to manage these gaps without taking on debt is through invoice factoring, which unlocks cash tied up in unpaid invoices.
Invoice factoring is a financial service where businesses sell their accounts receivable to a factoring company at a discount. The factoring company pays the business immediately, typically 80% to 95% of the invoice value, then collects payment directly from the customer. Once the customer pays the full amount, the factoring company releases the remaining balance minus their fees.
This process differs from traditional loans because businesses do not borrow money. Instead, they sell an asset - their unpaid invoices - to access funds they have already earned. The factoring company assumes responsibility for collecting payment from customers, which removes the collection burden from the original business.
The invoice factoring process follows these steps:
A business completes work or delivers products to customers and creates invoices with standard payment terms, usually 30 to 60 days.
The business submits approved invoices to the factoring company, typically through an online portal or email system.
The factoring company verifies the invoices and checks the creditworthiness of the customers who owe money. This process usually takes 1 to 2 business days.
The factoring company provides an advance payment, typically 80% to 95% of the invoice value, directly to the business within 24 to 48 hours.
The factoring company becomes responsible for collecting payments from customers. Customers send payments directly to the factoring company instead of the original business.
Once customers pay their invoices, the factoring company releases the remaining balance to the business, minus factoring fees that typically range from 1% to 5% of the invoice value.
There are two main types of invoice factoring arrangements:
In recourse factoring, the business remains responsible if customers fail to pay their invoices. If a customer does not pay within the agreed timeframe, usually 90 days, the business must buy back the invoice or replace it with a performing invoice. Recourse factoring typically offers lower fees because the factoring company has less risk.
Non-recourse factoring transfers the risk of customer non-payment to the factoring company. If approved customers fail to pay due to insolvency or bankruptcy, the factoring company absorbs the loss. This arrangement costs more but provides complete protection against customer default.
Invoice factoring and invoice discounting are two ways businesses can access cash tied up in open invoices, but they differ in how payments are collected and how much control the business keeps over customer interactions.
Invoice factoring provides several advantages for businesses:
Businesses receive funds within 24 to 48 hours instead of waiting 30 to 90 days for customer payments. This immediate access helps maintain operations and take advantage of growth opportunities.
Invoice factoring does not create debt on company balance sheets because businesses sell assets rather than borrow money. This arrangement preserves credit lines for other business needs.
Factoring companies handle customer collections, allowing businesses to focus on core operations instead of chasing payments. Professional collection services often result in faster customer payments.
Non-recourse factoring protects businesses from customer bad debt, reducing financial risk from customer defaults or bankruptcies.
Factoring limits increase automatically as sales grow, providing more funding as businesses expand without requiring additional credit applications.
Invoice factoring costs vary based on several factors:
● Factoring Rates: Factoring fees typically range from 1% to 5% of invoice value, depending on invoice size, customer creditworthiness, and factoring volume. Larger invoices and established customers usually qualify for lower rates.
● Advance Rates: Most factoring companies provide advances of 80% to 95% of invoice value. Higher advance rates reduce the amount of funds tied up in reserves but may increase factoring costs.
● Additional Fees: Some factoring companies charge setup fees, monthly minimums, or wire transfer fees. Businesses should review all fee structures before selecting a factoring company.
● Recourse vs Non-Recourse Pricing: Non-recourse factoring typically costs 0.5% to 1% more than recourse factoring due to increased risk for the factoring company.
Factoring companies evaluate both businesses and their customers when approving factoring arrangements:
● Business Requirements: Most factoring companies prefer applicants to have at least six months of operating history and monthly sales of around $10,000 or more. However, some providers may work with newer operations or lower volumes depending on the customer base and industry.
● Customer Credit Requirements: Factoring companies focus primarily on customer creditworthiness rather than the business applying for factoring. Customers must demonstrate the ability to pay invoices according to agreed terms.
● Invoice Requirements: Factoring companies typically require clean invoices for completed work or delivered products. Some companies factor progress billing or milestone payments, but most prefer invoices for finished deliverables.
● Industry Restrictions: Certain industries face restrictions or higher costs for factoring services. These include construction, restaurants, retail, and businesses with high chargeback rates.
Selecting the right factoring company requires evaluating several factors:
● Industry Experience: Factoring companies that specialize in specific industries often provide better service and understand unique business challenges. They may offer more flexible terms and faster processing.
● Fee Structure: Compare total costs, including factoring rates, advance percentages, and additional fees. Some companies advertise low rates but charge high fees that increase overall costs.
● Customer Service: Evaluate how factoring companies communicate with customers and handle collection activities. Poor customer service can damage business relationships.
● Technology Platform: Modern factoring companies provide online portals for invoice submission, funding requests, and account management. These platforms streamline the factoring process and provide real-time account information.
● Contract Terms: Review contract length, termination clauses, and minimum volume requirements. Some factoring companies require long-term contracts, while others offer more flexible arrangements.
Invoice factoring provides businesses with immediate access to cash flow by converting unpaid invoices into working capital. This financial tool helps businesses maintain operations, fund growth, and manage cash flow challenges without taking on debt. The process involves selling invoices to factoring companies that advance funds and handle customer collections.
To use invoice factoring effectively, businesses should review the terms carefully, work with a reputable provider, and maintain clear communication with their customers. It should be considered alongside other financing options, based on the company’s structure and financial needs.
1. How quickly can businesses receive funds through invoice factoring?
After completing the initial setup with a factoring company, businesses generally receive funds within 24 to 48 hours once invoices are submitted and approved. Some companies provide same-day funding to clients with a strong payment history and pre-approved customers. However, the first transaction may take longer, as it involves due diligence and account verification.
2. What percentage of invoice value do factoring companies typically advance?
Most factoring companies advance between 80% and 95% of the invoice value when the invoice is approved. The remaining amount, minus the factoring fee, is paid to the business once the customer settles the invoice. In industries like staffing and transport, advanced rates can reach up to 95% or more, depending on customer reliability and invoice volume.
3. Can businesses factor invoices from all customers?
Factoring companies evaluate each customer’s credit history and payment behaviour before agreeing to purchase invoices. If a customer has a history of delayed payments or defaults, their invoices may be excluded. Some factors also place limits on how much they are willing to fund per customer to manage risk exposure.
4. What happens if a customer disputes a factored invoice?
In a recourse agreement, the business remains responsible for any unpaid or disputed invoices. If a customer refuses to pay, the business may be required to replace the invoice or repay the amount advanced. In a non-recourse agreement, the factoring company typically absorbs the loss if the customer defaults due to insolvency. However, the business may still be asked to provide supporting documentation to address any disputes.
5. How does invoice factoring affect business credit scores?
Since invoice factoring involves the sale of receivables rather than borrowing, it does not usually affect a business's credit score. However, factoring companies often file a Uniform Commercial Code (UCC) statement, which appears on public records and may be visible to other lenders. While this filing does not lower the credit score, it can influence a lender’s assessment during future credit evaluations.
