Invoice Factoring Guide – Process, Costs & Requirements
Interested in learning about factoring and how it can help you reach your financial goals? Here’s a simple explanation of factoring concepts, so that you don’t have to spend your valuable time searching for answers.
All you need to know about factoring:
This guide should provide you with a comprehensive view of factoring. However, if you have any additional questions, please feel free to contact us or ask our smart factoring bot. We’re happy to help!
Invoice Factoring Definition
Invoice factoring (also known as accounts receivable factoring) occurs when a company sells its unpaid invoices to a factoring company at a discount.
B2B companies often choose factoring as a means to receive cash immediately.
A lot of people confuse invoice factoring with invoice financing. They are entirely different things! Invoice factoring is the selling of an asset, while invoice financing is simply a loan using invoices as collateral.
Requirements for Invoice Factoring
You will likely qualify if:
- Your business is a B2B company, selling to other businesses or the government.
- Your clients’ invoices are due in 30 to 90 days.
- Some of your clients have acceptable credit scores.
*Requirements can differ according to particular factoring company.
The Factoring Process
Here is how to factor invoices step-by-step:
|Step 1||Open a factoring account|
|Step 2||Sell and issue invoices due within 30 to 90 days.|
|Step 3||Submit receivables to the factor.|
|Step 4||Get a cash advance based on an agreed upon rate.|
|Step 5||The debtors pay the invoices.|
|Step 6||Payments go to a temporary reserve account.|
|Step 7||Factoring fees and advance are discounted and balance is sent to you.|
How Factoring Works Summary Image
Invoice Factoring Example:
- Your business sells and delivers product XYZ to Wholesale Inc., issues an invoice for $1,000 and gives the debtor 60 days to pay.
- Your company then agrees to the following terms with a factoring company:
- 80% advance rate
- 1% discount fee every 30 days
- The factoring company purchases your invoice and provides an $800 cash advance.
- On the 74th day, your debtor pays the invoice, which gets deposited into a bank account opened by the factoring company under your company’s name.
- The factor takes the payment and puts it into a reserve account.
- The factoring company takes $30 as a fee, subtracts the $800 already given to you and wires the remaining $170 (aka rebate) back to your company’s bank account.
How Much Cash Will You Initially Receive?
The advance rate is usually between 75 and 90% of the invoice value. The invoice value multiplied by the advance rate equals the amount you’ll get initially.
So if your rate is 80% and you factor an invoice worth $2000, you’ll get $1,600.
Keep in mind that when your customer pays the invoice, you’ll also get the remainder minus the agreed upon factoring fees.
How Much Do Factoring Companies Charge?
While factoring companies may operate differently from one another, most of them will charge you two kinds of fees:
- Factoring fees dependent upon the invoice value
- Administrative fees
If a factoring company says they have only one fee, it probably means the administrative fees are tied into their factoring rates.
Invoice factoring fees will vary based on invoice volume and the creditworthiness of your customers. However, you can expect a total monthly fee of 1% to 3% for the first 30 days and charges of 0.3% to 1% every 10 days thereof.
Factoring companies generally use one of the following rate structures to calculate factoring fees:
|Flat Discount||e.g. 2% every 30 days|
|Flat Fee and PRIME+Margin||e.g. 1% plus Prime (currently about 5% annual) +0.5|
While the second option sounds complicated, it amounts to a similar fee to that of a plain flat discount.
These are different across factoring companies, but here are some common operational fees:
- Account initiation fee: you’ll pay this just once for the factor to evaluate the original debtor’s credit background.
- Wire fees: expect this to be about $25, charged when cash from your reserve account is wired to your bank account. However, this fee doesn’t apply to every single invoice, but to the entire amount you receive, usually a combination of several cash advances and rebates.
- Mailing fees
- Monthly minimum volume fee: this is charged to you only if you originally agreed to sell a minimum of invoices (in order to lessen your fees), but you did not meet the minimum.
Strandard Factoring Contract Terms
Most factoring contracts include the following terms:
Recourse or Non-recourse Factoring
Recourse factoring means that if your customers don’t pay, you must return the cash advance.
While non-recourse theoretically means your company is off the hook should your customer not pay, the premium required for non-recourse factoring will usually be far beyond what you’d be willing to pay.
Furthermore, you’d need to obtain credit insurance to cover the factor in the event of delinquency, and your business customers need to be extremely creditworthy in order for you to be approved by the insurance company.
Given the hurdles, non-recourse factoring is rarely used.
Do You Need to Sell a Certain Amount of Invoices?
Expect most contracts to have a mandatory amount of invoices that must be factored, since fewer invoices mean higher operational expenses for the factor.
You’ll usually agree to this minimum early in the relationship with the factoring company based on feasible objectives.
Keep in mind that a higher minimum requirement should bring down the factoring rate.
Occasionally a factoring company will provide spot factoring, allowing you to factor a single invoice at a time. While this might make sense if you need just one cash jolt, you’d be paying much more than if you agreed to an ongoing factoring partnership.
What kinds of businesses find factoring advantageous?
It is important to note that only B2B (business to business OR business to government) companies are eligible for factoring. It is not suitable for retail companies.
Here are some industries that frequently use factoring as a means to access immediate cash flow:
- Apparel Manufacturers
- Commercial Service Providers
- Construction Contractors
- Distributors & Wholesalers
- Manufacturing Companies
- Temporary Staffing Agencies
- Transportation Companies
- Government Contractors
(please note that this is not a complete list, we serve hundreds of industries)
Why would you choose factoring services?
- You require a short-term cash flow boost for business costs, such as supplies and payroll.
- You are unable to obtain a traditional bank loan.
- You have a bank loan but need additional funding.
- You’re looking to avoid debt.
Here are some common problems shared by companies who seek factoring solutions:
- Overly leveraged
- Negative net worth
- Period of operating losses
- Delinquent taxes
- Bank credit rejection
- Negative net worth
- Use of maximum bank credit
- A past record of bankruptcies or forbearances
- Lack of credit history or bad credit
Factoring Pros & Cons
- Immediate access to funds for your business
- Less worrying about your customers’ payments
- Easy application process
- Easy to qualify
- Access to cash without debt
- Credit history of little importance
- Help for your accounts receivable team
- Not available to B2C (business to consumers) companies
- Pricier than traditional bank loans
- Factor will have some control of communication with debtors
- Not the answer to delinquent receivables
- In most cases, liability for debtors who are not creditworthy
Invoice Factoring vs. Bank Financing
If you’re fortunate enough to qualify for traditional bank financing, we encourage you to take advantage of it. It costs less than factoring, so the choice is obvious.
However, as it’s difficult to qualify, many businesses simply don’t have this option.
Perhaps you already utilize bank financing, but you’ve used your maximum amount allowed and don’t want to increase debt on your ledgers. In this case, factoring could be a viable solution.
Invoice Factoring vs. Invoice Financing
Make sure not mistake invoice factoring for invoice financing. Invoice factoring is simply the purchase of invoices at a discount. You get a cash advance for the purchase.
Factoring is not a loan. Invoice financing, however, is an asset-based loan. You borrow money based on a percentage of your accounts receivable, and your invoices serve as collateral.
We Are Here to Help You
We hope you now have a clear understanding of the invoice factoring process. However, if you have more questions feel free to ask our Zipfunder chatbot or call us at 1-855-323-2952.
Author Marc J Marin