How Does Invoice Factoring Work?

February 2019

As a business owner, you can access a wide variety of funding options. One of these options is factoring; a transaction in which a business sells its invoices (or receivables) to a third-party financial company that is commonly referred to as a “factor.”

The factor will ultimately receive payments on the invoices from the customers of the business. Because factoring utilizes business invoices or receivables as collateral, it’s often referred to as “accounts receivable financing.”

How does a business receive funds from factoring?

When an invoice is factored, the third party financial company advances you a percentage of the value of the invoice/s. You then receive the balance of the invoice (minus fees) after the Factor receives payment from your customer. Advance rates typically range from 80% to 95%. Your customer’s credit history typically plays a big role in the advance rate you’ll be eligible for.

How can factoring benefit your business?

Let’s say you average $50,000 in receivables every month. However, your customers may take longer than 30 days to pay what they owe. In the meantime, you’re still responsible for covering payroll, purchasing inventory, and paying rent.

With factoring, you receive a percentage of the cash value of those invoices quickly, allowing you to cover your expenses until your customers finally pay what they owe.

Even if the advance rate is 85%, you’ll still have access to $42,500. And while factoring offers a wide variety of benefits, its main advantage is that it offers quick payments on your invoices.

How many of your invoices should you factor?

Every company is different, so there is no universal answer to how many invoices your company should consider factoring. Some businesses only factor the invoices of customers who take the longest time to pay. Other businesses factor all of their invoices. Consider your needs and whether or not your business is being hindered due to issues revolving around delayed receivables.

The different types of factoring

There are two primary types of factoring: recourse and non-recourse factoring. Both have their pros and cons and should be researched carefully by a business owner before a choice is made.

Recourse factoring means the factoring client will take complete responsibility for payment of an invoice if the factor is unable to collect payment from a debtor, or customer. In other words, you are responsible if your customers fail to come through on their payment.

On the other hand, non-recourse factoring involves the business client selling all of their invoices to the factor who in turn takes all responsibility of collecting on the invoices. Some factors provide both recourse and non-recourse services.

Factor fees and contract terms you should be aware of

Just as business loans can have varying rates of interest depending on the lender you borrow from; factors tend to have varying fee structures depending on who you decide to work with. Some factors base their factoring fees on the overall monthly volume of receivables and the creditworthiness of the businesses’ customers.

Other factors require additional fees such as collateral, money transfers, shipping, and other business expenses. With so many factoring providers to choose from, understanding fee structures will help you to make a well-informed decision for your business. It will be your job to understand all of the fees you’ll be paying before signing a factoring contract. In most cases, factoring contracts are 12 months and can be renewed on an annual basis.

Is factoring right for your business?

Factoring can be a good choice, especially if long receivables are part of your typical business cycle. However, factoring is just one lending option amongst many, so its best to reach out to funding providers and see what offers best suit your needs.

If you require working capital quickly turn to One Park Financial. We can connect you with a large pool of funders who specialize in helping small business owners flourish and grow. Applying is a quick and painless process, and once you qualify (it’s a fast procedure!) you’ll have the money you need quickly to keep your business moving.