Invoice factoring is a type of accounts receivable financing that converts outstanding invoices due within 90 days into immediate cash for your small business. The factoring company will typically pay you in two installments for your invoice: an advance of roughly 80% of your invoice and the remaining 20% (minus factoring fees) after the invoice is paid.
In this article, we’ll discuss what invoice factoring is and how it works. We’ll also touch on invoice factoring costs and qualifications as well as how to choose a good factoring company. As a bonus, we’ll explain the difference between invoice financing vs invoice factoring and which might be best for your small business.
Before we dive in, we want to thank Fundbox for sponsoring this article. Fundbox offers fast, affordable invoice financing of up to $100K. With rates as low as 0.5% per week and repayment periods of 12 or 24 weeks, Fundbox can make waiting for invoices to be paid a thing of the past. Opening an account at Fundbox is free. After syncing your accounting software, just pick and choose which invoices to clear. You can have funds as soon as one business day.
What is Invoice Factoring?
Invoice factoring is a financing option available to businesses that invoice businesses (B2B) or government agencies (B2G). Invoice factoring provides short term working capital in exchange for selling and assigning invoices to a factor. The factor advances the company roughly 80% of the invoice’s value. Then, once the invoice is paid, the factor pays the remaining 20% (minus fees).
Though similar, invoice factoring is not the same thing as invoice financing (or accounts receivable financing), although the terms are often used interchangeably. Invoice financing is more streamlined, easier to use, and doesn’t require the assignment of invoices like factoring does. Read more about invoice financing here.
In addition to being able to work with B2B and B2G invoices, an invoice financing company like Fundbox can also work with B2C invoices. Businesses in need of working capital that don’t invoice their customers at all may want to read our articles about short term loans and merchant cash advances.
Invoice factoring is typically a solution for short-term cash flow problems. It is frequently used as a way for businesses to simplify their cash flow conversion. Invoice factoring is not traditionally the type of financing that is used for big capital investments. This type of project is typically done with long term loans like SBA loans.
How Does Factoring Work?
There are five main steps involved in invoice factoring:
Step 1: Invoice Your Customer
Once you have provided products or services to your B2B or B2G customer then you issue an invoice for them to pay you. To qualify for factoring, these invoices must be payable within 90 days.
Step 2: Sell and Assign the Invoice to a Factor
You find a factor you want to work with, go through the application process, and sell them all of your outstanding invoices. When you submit an invoice to a factor a few things will happen.
First, the factor will determine if you meet eligibility criteria to receive financing. They will also conduct due diligence on the customers you’re invoicing to see if they are good credit risks. If the factor decides to approve your business based on that research, you and the factor will sign a financing agreement. The agreement will set an initial maximum dollar amount that you can borrow, which is the maximum factored amount outstanding at any given time.
Step 3: The Factor Pays You an Advance
The factor gives you an initial advance called an advance rate. The advance rate is generally around 80% of the value of the factored invoice. The amount of your advance depends on the size of your transaction, your industry, and other risk parameters.
At this point, the factor may also send out a “notice of assignment” to the clients you have chosen to factor, or they may ask you to do so. The notice of assignment states that your company has assigned the factor as the entity to receive future payments for invoices you issue them. All payments will go to a lockbox account (like a designated account for the factored invoices to be paid) which is set up by the factor.
In industries where factoring is common, telling a client you’ve assigned their invoice might not be a problem. If factoring isn’t common in your industry, you might benefit from invoice financing, which doesn’t require invoice assignments.
Step 4: Your Client Pays the Factor
Your client will pay the factor within 90 days according to the terms of the invoice.
Step 5: Factor Forwards You the Remaining Balance Minus Fees
After receiving payment from your client, the factor will give you the remaining balance of the invoice, called the reserve amount, minus their fees.
Invoice Factoring Costs & Qualifications
Invoice factoring is a good working capital solution for businesses of many different ages and sizes, as long as you have qualifying invoices. Many factoring companies will even work with you if you’re a startup. The typical fees and overall costs can be tricky to understand, but all typically fall into the ranges in the table below.
Invoice Factoring Costs & Qualifications
|Amount You Can Borrow||$10k+ per month|
|Time to Qualify||2 - 7 Days|
|Time to Receive Funds||1 - 3 Business Days|
|Invoice Qualification Requirements||Payable within 90 days and free of all liens.|
|Other Common Qualifications||Invoice B2B or B2G customers No serious legal or tax problems 2+ Years in business|
|Paperwork Requirements||Application with standard personal and business information Accounts receivable aging report Accounts payable aging report Tax returns (personal & business) Corporate paperwork|
|Discount Rate||0.5% - 5%|
|Other Fees||Varies by Factor(see potential breakdown below)|
Factors and their lending programs can vary significantly. Some factors specialize in lending against invoices due in 90 – 120 days while others specialize in larger or small borrowing limits. Fundbox gives businesses the flexibility of easily clearing invoices for as little as $100 and as much as $100,000. Not only that, but you can skip the intensive application process. Simply create an account for free, then sync your bookkeeping software. That’s it.
How to Qualify for Invoice Factoring
Qualifying for invoice factoring is easier than qualifying for long term financing, like commercial real estate loans. While credit scores, annual revenues, and profitability can be significant hurdles for other types of financing, those are less often issues with invoice factoring. Most factors care about three primary things:
- You must invoice business (B2B) or government (B2G) customers. Your customers must have good credit scores and they must be established businesses. The factor will need to feel comfortable that your customers are likely to pay off your invoice.
- The invoices must be due and payable within 90 days and unencumbered by other loans. (For example, you can’t have another short term loan outstanding where the same invoice is pledged as collateral.)
- Your business should not have a history of serious tax or legal problems.
Some factors will have other requirements for your business, such as a minimum credit score or minimum time in business, but these requirements are usually far less stringent than other lenders. Learn more in our invoice factor buyer’s guide about the requirements of leading invoice factoring companies.
If your business invoices consumers rather businesses or government agencies, you may qualify for invoice financing at Fundbox.
Invoice Factoring Costs
The base cost (without additional fees) of an invoice factor depends on two things:
- Discount Rate (or Factor Rate) – The discount rate is the primary cost of borrowing money from the factor and is typically charged on a weekly or monthly basis. The industry range is .5% – 5% of the invoice value per month. Many factors have a tiered system for their discount rates so the more you factor in a month the lower your discount rate is.
- Length of Factoring Period (time it takes your customer to pay) – Discount rates are charged at regular intervals (usually weekly or monthly), so the length of time it takes for the customer to pay your invoice will determine your cost.
Example of Invoice Factoring Costs
Let’s illustrate the terms above with an example. Suppose you factor a $10,000 invoice at an advance rate of 80% and a discount rate of 3% per month. In this case, you would receive $8,000 upfront. If your client makes full payment on the invoice in 30 days, the factor will pay you the remaining $1,700 you are due, bringing the total amount you receive to $9,700. The remaining $300 is kept by the factor as their fee.
Other Invoice Factoring Fees to Look Out For
Some factors charge additional fees other than the discount rate. Some “hidden fees” to watch out for are:
- Origination Fees: Upfront costs associated with initiating a new factoring relationship and opening your account. Could be up to $1,000.
- Incremental Fee: If your discount rate is a flat fee then you may be charged an incremental fee to increase the total discount paid to the factor as an invoice ages. This fee can range from 0.35% – 1%.
- Service Fee or Lockbox Fee: This is a flat fee that your factor may charge you to keep a lockbox (like a designated account for the factored invoices to be paid) open for your customers to pay their invoices to. It can range from $50 – $500 per month.
- Collection or Overdue Fees: Your factor may charge you for their efforts required in collecting past due payments from your customers. Some will even charge you a flat fee for any payment that becomes past due. These fees vary greatly by factor and could be nothing to a few thousand dollars.
- Unused Line Fee: Charged for the unused portion of a factoring facility for a given month. It is typically stated as a percentage and charged on a monthly basis. Can range from 0.15% – 0.5%
- Monthly Minimum Volume Fee: In the event you don’t generate a certain level of fees for your factor in a given month then they may charge you a fee up to $1,000.
- Renewal Fee: An annual fee applied after every full year the line is open. Could be up to 1% of the factoring facility size.
- ACH Transaction Fee: A fee of $5 – $30 that is charged for every advance or disbursement issued from the factor to you.
- Wire Fee: Charged if you request to receive a wire instead of an ACH, which is the preferred method of payment by most factors. The factor passes on the charge from their bank to you, typically $15 – $50.
- Credit Check Fees: These are small in comparison to the other fees, but your factor may pass the cost on to you for any credit checks they need on you or your customers.
It isn’t likely that any factor you work with will charge you all of the fees above. However, because of the amount of different fees that you could be charged it’s important to do three things:
- Ask each factor company you are interested in working with for a breakdown of their fees.
- Carefully review your factoring contract (with the assistance of an attorney if needed).
- Compare different factoring proposals before signing on the dotted line.
Invoice financing companies, like Fundbox, are far more straight forward with their fees. For example, Fundbox charges just 0.5% – 0.7% per week of the value of the invoices you choose to clear. It’s that simple. Opening an account at Fundbox is free, does not involve a credit check and you can see if you qualify for financing in just a few hours.
APR vs Total Cost of Capital
If you measure the costs and fees of invoice factoring as APR it might look a little higher than you’re used to seeing with more traditional financing solutions.
But with short term borrowing, like invoice factoring, total cost of capital can be more important than the APR. Total cost of capital is how much you will pay in your discount rate and other fees for the life of your repayment term on each factored invoice.
While long term financing may have an APR around 7%, short term working capital providers have APRs that range from 30% – 120%. Invoice factoring typically falls in between the two, with APRs that range from 28% – 60%.
Keep in mind that comparing the effective APR of a 0.5% – 1% weekly discount rate to the APRs of more traditional loans can be slightly misleading. That’s because you’re borrowing the funds for a short period of time so the total cost of borrowing those funds will be relatively small.
For example, let’s say you factor $10,000 for 30 days with a 1% weekly discount rate. Your total cost to factor would be $400, even though technically your APR would be 52%. But if you borrow the same $10,000 and spread out the payments with a 5 year repayment term at a 7% APR, then the total cost of capital is $1,880.72.
How to Choose the Right Invoice Factoring Company
There are over 700 factoring companies in the United States. There is tremendous variety in the services they offer, how they conduct their business, and what they charge. Do your research carefully so that you don’t end up with unintended costs or consequences. Here are the things to consider when shopping around:
Customer Contact with the Factor
One aspect of invoice factoring that turns away a lot of businesses is the level of contact between the factor and your customers.
This worry stems from the fact that your customer will have to pay the factor, not you. Some small business owners imagine this will result in their hard-earned customer being repeatedly contacted by a company they’ve never heard of being told to pay up. These concerns aren’t completely unfounded, but they are exaggerated.
In reality, some factors will want direct communication with your customer to verify invoices, verify the assignment of the invoice, and make payment arrangements. However, this is more common in industries where factoring in general is more common and preserving relationships is a top priority.
Some factors create an arrangement where the factor has far less (and in some cases, zero) direct communication with your customer. In some cases this is done by opening a new bank account which the factor controls but which is listed in your business’s name. You then notify your customer of the new account information and if the factor contacts your customer then they will simply present themselves as your billing department.
The invoice financing available through Fundbox doesn’t involve any customer contact, which makes it a very discreet option for businesses that are looking for between $100 – $100K in working capital.
Time to Get Funding
The speed of getting money may matter to you more than anything else if you’re depending on it to make payroll or buy something essential for your business.
The timeframe for you to be funded using invoice factoring is comparable to getting a short term loan, but it varies by factor. You can generally qualify within 2-7 days, and be funded in 1-3 business days after that.
Invoice financing companies, such as Fundbox, are even faster. They require no paperwork because their application and approval processes are completely electronic. They can approve you in hours and get you funded as soon as 1 business day.
Recourse vs. Non-Recourse Factoring
One of the most important concepts to understand when considering invoice factoring is recourse factoring vs. non-recourse factoring. This tells you what happens if your customers don’t pay the invoice on time.
Recourse factoring means that the factor has the right to collect payment from you if your customer doesn’t pay the invoice within a reasonable time after its due date. This can be a big problem if you have already spent the money you received from the factor and don’t have additional revenue coming in to settle the debt. This is why you should only factor invoices to customers who reliably pay on time. Fees can continue to accrue until the factor is paid, often creating a new cash flow problem.
Non-recourse factoring is when the factor accepts the risk that the customer won’t pay. In this case, even if your customer doesn’t pay the invoice on time, your business won’t be on the hook for it.
Some firms advertise “non-recourse” factoring, but on the contract, they list several reasons why an invoice can be exempt from no recourse. Other factors will offer partial-recourse agreements. Small businesses should tread cautiously and read their entire contract carefully to make sure what they will and won’t be responsible for if their clients don’t pay the invoice or pay the invoice late.
Spot Factoring vs. Contract Factoring
Spot factoring is when a company sells and assigns a single invoice to a factor. While this might be preferred by the company, many invoice factoring companies do not prefer to factor in this way. Factors don’t like spot factoring because the application process and underwriting isn’t significantly different than if they were to factor all your invoices. That means the factor is doing more work by not able to earn much money off your account.
Contract factoring is far more common that spot factoring and typically requires a minimum monthly volume be factored with them (usually $10K+), or that every invoice to a specific customer be factored.
In general, we’re not fans of the long-term commitments required by contract factoring. Many small businesses often have a variety of customers who pay on different terms, and their financing needs may change, making the flexibility of spot factoring a better option. Fundbox lets you choose which invoices to clear and when to clear them. This gives your small business a high degree of flexibility.
Factoring is an area in which industry familiarity matters. The industry you and your customers are in can affect your terms and cost. Some factors specialize in providing financing to specific industries. Conversely, some factors won’t provide financing to certain types of industries.
Do your research and find a factor that understands the needs and norms of your industry.
Invoice Factoring vs Invoice Financing: Which is Right for Your Business?
Invoice financing (aka accounts receivable financing or AR financing), is a technology based financing solution that gives you a simple way to fix your cash flow problems by advancing payments for your outstanding invoices.
Invoice financing does not require the sale or assignment of invoices, and there is no third party interaction between your provider and your customers. This makes invoice financing faster and easier than traditional invoice factoring.
“Invoice financing is different from invoice factoring in a few important ways,” says Fundbox CEO, Eyal Shinar. “First, invoice financing doesn’t interfere with your clients relationships. Most factoring companies will collect directly from their customers’ clients, which can create an awkward dynamic. Also, invoice financing companies will often advance a larger percentage of the invoice value (up to 100%) whereas factoring companies often only give around 85% of the value. Finally, with invoice financing you can advance as many, or as few, invoices as you want and you’ll only pay fees when you advance. Often factoring companies purchase all of a small business’s accounts receivables so the business might get saddled with a lot of unnecessary debt.”
Typically invoice financing has three main steps:
If your business is looking for a seamless, fast invoice financing solution, set up an account for free at Fundbox. Sync your accounting software and see if you qualify for financing. With rates as low as 0.5% per week and funding up to $100k, Fundbox can help you turn unpaid invoices into cash, fast.
While the terms invoice factoring and invoice financing are often used interchangeably, they are different funding options. Let’s look at how Invoice Financing compares to Invoice Factoring in the table below.
Invoice Financing vs Invoice Factoring
|Invoice Financing(Accounts Receivable Financing)||Invoice Factoring|
|Amount You Can Borrow||$100 - $100,000||$10k - $10+ million|
|Time to Qualify||Within hours||2-7 Days|
|Documentation Required||Online application Allow online connection from financing provider to your accounting software||Application with basic personal and business information Accounts receivable aging report Accounts payable aging report Tax returns (personal & business) Corporate paperwork|
|Assignment of Invoice?||No||Yes|
|Does the Factor Contact Your Customers?||No||Yes|
|Apply for Financing||Visit Fundbox||Find a Factor|
When Invoice Factoring is the Right Option
Invoice factoring is right for you if you need a consistent cash flow solution and you invoice B2B or B2G customers. You must be prepared to bring a partner into your business that is going to be working with you on invoice collection for the foreseeable future. Some of the characteristics that may draw you to invoice factoring include:
- Factoring is a relationship driven financing option: When working with a invoice factoring company, you and the factor will be in regular contact, typically every week. You’ll work together to factor new invoices, collect outstanding invoices, and make repayment decisions. Your factor can help you simplify your cash flow conversion process.
- Your customer’s creditworthiness is more important than yours: Another aspect of invoice factoring that can be a huge benefit to small business owners is that you’re relying on your customer’s creditworthiness, not your own. So if your business has incurred some credit card debt during a slow season (and saw your credit score decline as a result) but is billing on a big contract now, invoice factoring is a way to avoid the usual credit requirements for more traditional loans.
When Invoice Financing is the Right Option
“Invoice financing can be a great solution for businesses looking to grow at a controlled pace. With invoice financing, you’re leveraging your business’s existing cash flow to grow, so there’s less of a risk of over-extending your business with too much credit or credit at unfavorable terms,” say Eyal Shinar. “Similarly, invoice financing doesn’t rely on traditional credit underwriting the way a line of credit or term loan would, which makes it a good option for businesses that may have less than stellar credit scores. So if you’re a business looking to grow or manage your cash flow more effectively, invoice financing may often be a smart way to do so.”
Invoice financing is typically right for you if you’re looking for financing to solve a short-term cash flow issue or are looking to generate some short-term growth capital. You may also want to consider invoice financing if you’re looking for any of the characteristics that invoice financing has over invoice factoring, which include:
- Faster than Factoring: Invoice financing companies like Fundbox can fund your invoices as soon as 1 business day. You don’t have to mess with assignment notices because invoice financing is more like a line of credit product in that you are borrowing based on your accounts receivable.
- More Flexible than Factoring: One of the best things about invoice financing is its flexibility. You can finance specific invoices which match your working capital needs in terms of both dollars and timing. For example, if you need money to cover three weeks of expenses, you can pick an invoice to finance which gives you the cash to cover your next three weeks’ worth of business expenses.
- Easier than Factoring: Invoice financing is usually easier to qualify for than invoice factoring and the process is faster. This is thanks to the technology they use to speed up the process and give your application an approval within a matter of hours. With a company like Fundbox you can apply today and potentially have funds as quickly as tomorrow.
- No Hidden Fees: With invoice financing you pay back each invoice within 12 or 24 weeks by paying one weekly payment that covers the cost of the invoice for 1 week and a small fee. The nice thing about invoice financing is that there are typically not any extra fees like there can be with invoice factoring. It is much easier to determine what you will be paying before you decide to borrow.
- No Third Party Interaction With Your Customers: Because you do not assign your invoices to your provider there is no need for them to ever contact your customers.
If you think invoice financing is a better fit for your business than factoring then you should consider using a provider like Fundbox. They can approve your business within hours and help you get funded for your unpaid invoices in as soon as one business day. Their flexibility allows you to pick and choose which invoices you want to finance, and they will never contact your customers.
Factoring can seem a little more complicated than getting a loan from a bank. However, what makes factoring complicated is also what makes it appealing. You can borrow money based on your unpaid customer invoices to meet your immediate cash flow needs. As long as your clients pay in a timely manner, the cost of factoring is more affordable than many other short term business loan alternatives.
Fundbox offers fast, affordable invoice financing of up to $100K. With rates as low as 0.5% per week and repayment periods of 12 or 24 weeks, Fundbox makes waiting for invoices to be paid a thing of the past. Opening an account at Fundbox is free. If you’re approved after syncing your accounting software, you can just pick and choose which invoices to clear, with funds transferred as soon as 1 business day.