What Invoice Factoring Is & How It Works

Invoice factoring is a type of accounts receivable financing that converts invoices due within 90 days into immediate cash for your small business. The factoring company will typically pay out two installments for your invoice: an advance of 80% of your invoice and the remaining 20% (minus fees) after the invoice is paid.

BlueVine offers a next-day invoice factoring facility for up to $5 million. Factoring invoices with BlueVine is fast and business owners can complete the entire process online. With an application that takes 10 minutes, approval times under an hour, and funding the next day, borrowers can get access to capital quickly and worry-free.

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What Is Invoice Factoring?

Invoice factoring provides short-term capital in exchange for selling and assigning invoices to a factoring company (referred to as a factor) and is a form of asset-based lending. The factor advances you 80% of your invoice value. Once the invoice is paid, the factor pays the remaining 20% (minus fees). The best invoice factoring companies offer funding to businesses that do a lot of business-to-business (B2B) or business-to-government (B2G) invoicing.

Though similar, small business 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.

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. Factoring financing is most often not used for big capital investments.

How Invoice Factoring Works in 5 Steps

With invoice factoring, your account receivables (invoices) due within 90 days are sold to a third party. It’s a quick and easy immediate cash source. You’ll receive an initial advance of approximately 80% of your invoice upfront. Once your customer pays the invoice, you’ll receive the remaining 20% (minus fees).

The five steps in invoice factoring are:

1. Invoice Your Client

Once you have provided products or services to your B2B or B2G customer, you issue an invoice for them to pay you. To qualify for small business invoice factoring, these invoices must be payable within 90 days.

2. Sell & Assign the Invoice to a Factor

Prior to being able to receive factoring financing, you will need to find a factoring company you want to work with and then go through the application process. The factor will determine if you meet the eligibility criteria to receive financing and conduct due diligence on the customers you’re invoicing to see if they are good credit risks. There are several common invoice factoring mistakes to avoid at this step.

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. Ensuring that customer pay on time and are generally creditworthy is one of the best ways to improve an invoice factoring application.

Once you have a factoring relationship established with a factor, you will sell them all of your outstanding invoices. When you submit an invoice, the factor will review the invoice for eligibility and issue the advance.

3. Factor Issues an Advance on the Invoice

After submitting your invoices, the factor gives you an initial advance based on the agreed-upon advance rate. The advance rate is generally around 80% of the value of the factored invoice, known as the borrowing base. 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.

Some industries are more accustomed to invoice factoring than others. Trucking and shipping companies commonly use freight factoring, and in industries like construction invoice factoring is common. 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.

4. Client Pays the Factor

Your client will pay the factor within 90 days according to the terms of the invoice. The factor will typically handle the collection on all the invoices you assign to them. Generally, the factor tries to follow your history of collection techniques, unless the client is past due. This means there is generally no negative impact on your customers.

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. While factoring companies don’t disclose an APR, business owners can estimate the costs using an invoice factoring calculator. For example, if your advance rate was 80% with a monthly factor rate of 3%, and your customer repaid within 30 days, the factor would pay you the remaining 17% at this point.

Who Invoice Factoring Is Right For

Invoice factoring is right for businesses needing a consistent cash flow solution and that invoice at least $25,000 per month to B2B or B2G customers. If you choose business factoring, you need to be prepared to bring the factor in as a partner on your accounts receivable management and collections processes. This includes a willingness to give up some customer control, as the factor will likely have contact with your customers. Some business owners need money to order goods for completed orders and may be better served by a purchase order financing company.

Sam Johnson, a former small business banker and business consultant who graduated with a bachelor’s degree in finance from the University of Washington, said the following about small business factoring:

“Invoice factoring is a powerful tool to help small businesses grow and function more effectively. Not only does the process provide capital, but it frees up time and resources from accounts receivable and collections. The benefits that a small business can realize with additional financial capital and human capital are enormous!”

Invoice Factoring Qualifications

Invoice factoring is a good working capital solution for businesses of many different ages and sizes, as long as your business qualifies and has qualifying invoices. In general, you can qualify for invoice factoring if you have been in business for at least two years, have invoices due within 90 days, and have no serious tax or legal problems.

The typical qualifications for invoice factoring are:

Invoice Factoring Qualifications

Qualifying for invoice factoring is easier than qualifying for long-term financing. Generally, if you have B2B or B2G invoices due within 90 days and no recent tax or legal issues, you can qualify for invoice factoring. While credit scores and annual revenues can be significant hurdles for other types of financing, they are less often issues with invoice factoring.

Ben Janin, an experienced former small business banker, said:

“I had a client who was in technology. At one time, they were on the top of the world, and then the rug was suddenly pulled from underneath them to the point that the company was nearly killed off. In this instance, a reputable factoring company was able to meet the demands of the struggling technology supplier. Goods were produced, payroll was met, and the lights stayed on. The business leaders took great pride in the company and it was very important to them that they kept their 100-plus team members employed.”

– Ben Janin, former Banker and Sales and Marketing Executive, United Moving & Storage

Most factors care about three primary things:

1. Who you invoice: 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.
2. When invoices are due: 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).
3. Credit history: 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. Comparing the qualification requirements of the leading invoice factoring companies can help you decide which factoring company is best for your business.

BlueVine offers to fund small business owners with a minimum credit score of 530. It offers 85% to 90% of the invoice value and can fund businesses with at least $100,000 in annual revenue and three months in business. Funding only takes one day and business owners can qualify to factor up to $5 million in invoices.

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Invoice Factoring Rates & Fees

The primary cost associated with factoring financing is the discount rate, which is sometimes referred to as the factor rate. Invoice factoring rates generally range from 0.5% to 5% of the amount of the invoices factored. Additionally, factoring companies may charge additional fees, such as origination fees or minimum factoring fees. It’s important to be aware of what these fees may be.

Invoice Factoring Rates

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 0.5% to 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.

For example, factoring a $10,000 invoice would look like this:

Other Invoice Factoring Fees to Look Out For

In addition to the discount rate charged on your factored invoices, there are other fees that you may encounter when using business factoring financing. Some factoring companies may charge you origination fees, services fees, collection fees, or an assortment of other fees. It’s important to understand any fees you may be charged as part of your financing package.

Some additional fees you may encounter with invoice factoring include:

• Origination fees: Upfront costs associated with initiating a new factoring relationship and opening your account; these 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% to 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, to which your customers will pay their invoices. It can range from $50 to $500 per month.
• Collection or overdue fees: Your factor may charge you for their efforts required for 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. It can range from 0.15% to 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, they may charge you a fee up to $1,000.
• Renewal fee: An annual fee applied after every full year the line is open. This could be up to 1% of the factoring facility size.
• ACH transaction fee: A fee of $5 to $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 to $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.

Any additional fees that may be charged by the factor should be stated in your factoring agreement. Carefully read through the agreement to make sure that you understand what the fees are and when they apply. If you are applying with multiple factors to see which one will offer you the best deal, make sure to compare the fees that each charges as well as the discount rate.

Understand & Compare Invoice Factoring Fees

When deciding on a factoring company, or choosing between multiple factoring companies, it’s crucial to understand all of the costs associated with the financing. Review your contract to determine what fees you may be charged and under what circumstances they will be incurred. If comparing multiple factoring companies, compare not only the advance and discount rates, but also the fees that each factor charges.

Because of the number of different fees that you could be charged, it’s important to:

• Understand the fees: Ask each factor company you are interested in working with for a breakdown of their fees. Having this information will allow you to compare different providers.
• Review the contract: Carefully review your factoring contract (with the assistance of an attorney, if needed) to ensure that you fully understand what you are agreeing to.
• Evaluate your options: Compare different factoring proposals before signing on the dotted line.

BlueVine’s fees are simple and straightforward because it only charges a discount rate. The discount rate ranges from 0.25% to 1.35% per week, based on the value of the invoice. Business owners can apply online in minutes and factor up to $5 million in invoices as soon as the next business day.

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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 what you’re used to seeing with more traditional financing solutions. With short-term borrowing, like invoice factoring, the total cost of capital can be a more important measure than the APR. The total cost of capital is the total amount you will repay on each factored invoice.

In general, the typical APRs you can expect with different financing options are:

• Long-term financing: 7% to 15% APR
• Short-term working capital loans: 30% to 120% APR
• Invoice factoring: 28% to 60% APR

Comparing the effective APR of a 0.5% to 1% weekly discount rate for invoice factoring to the APRs of more traditional loans can be slightly misleading. Despite the higher APR, the short repayment period equates to a relatively small cost of capital.

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 your effective APR would be 52%. However, if you were to borrow the same $10,000 and spread the payments over a five-year repayment term at a 7% APR, the total cost of capital would be $1,881.

How to Choose the Right Invoice Factoring Company

There are a number of aspects to consider when you are selecting a provider for factoring financing. You need to determine the level of customer interaction you are comfortable with the factor having with your customers, as well as how quickly you need funding, whether you want recourse or non-recourse financing, and whether you want spot factoring or contract factoring; all of these will impact the factoring company you choose.

Some things to consider when shopping for factoring financing are:

Customer Contact With the Factor

One aspect of invoice factoring that intimidates 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 make payments to the factor instead of directly to 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 and being hassled for payment.

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 is more prevalent and preserving customer relationships is a top priority for the factor.

Some factors create an arrangement where the factor has far less (and in some cases, zero) direct communication with your customer. This can be done by opening a new bank account in your business’ name, with control of the account given to the factor. Your customers are notified of the new account information for payment, and if the factor contacts your customer, they simply present themselves as your billing department.

Time to Get Funding

Another important consideration is how quickly you can receive funding, and this may matter to you more than anything else if you need cash to make payroll or buy something essential for your business. With factoring financing, you can generally qualify within two to seven days and be funded in one to three business days after that. The exact funding speed will vary by factor.

Recourse vs Non-recourse Factoring

One of the most important concepts to understand when considering invoice factoring is recourse factoring versus non-recourse factoring. 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. Non-recourse factoring is when the factor accepts the risk that the customer won’t pay.

Recourse factoring can become problematic if you have already spent the money you received from the factor. 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. However, with non-recourse factoring, 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 then 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 they understand 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 allows you to sell and assign individual invoices to a factor. While this may seem ideal for your business, many invoice factoring companies prefer not to factor in this way. The application process and underwriting aren’t significantly different than if you were to factor all of your invoices.

Contract factoring is far more common than spot factoring, and is the preferred method of factoring for most business factoring providers. Typically, contract factoring requires a minimum monthly invoice volume be factored (usually $10,000 or greater), or requires that every invoice to a specific customer be factored.

Industry Familiarity

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.

Pros & Cons of Invoice Factoring

Some of the benefits associated with factoring financing include that there is generally no minimum credit score requirement, it’s a fast way to receive cash, and your accounts receivables will be handled by experts. Conversely, the factoring company may have direct contact with your customers, selling your invoices relinquishes a level of control, and factoring can be expensive.

Pros of Invoice Factoring

The pros of invoice factoring include:

• Creditworthiness of your customers is considered: With invoice factoring, your customer’s creditworthiness is more important than yours. This means you’re able to get financing even if you have poor credit.
• You get to work with accounts receivable experts: A potential upside to invoice factoring is the ability to develop relationships with accounts receivable (AR) management experts. Since this is what your invoice factoring company does on a daily basis, it likely has really good accounts receivable management techniques.
• Provides a quick source of cash: Invoice factoring provides a quick source of cash. You can typically get approved within two to seven days and funded in one to three days. There are, however, other fast business loans you could consider. It’s always good to weigh your options.

Cons of Invoice Factoring

The cons of invoice factoring include:

• Factor may communicate with your customers: You can expect your invoice factoring company to contact your customers, and the level of interaction will vary by provider. If your business is in an industry where invoice factoring is common, this may not be a problem.
• Cost is expensive: With invoice factoring, not only are the interest rates higher than with other types of financing, but there is also the potential for additional fees. It’s important to read your contract closely to make sure you understand the total costs involved with this form of financing.
• Your invoices are sold: A feature of invoice factoring is that you’re selling, or assigning, your invoices to the factoring company. While this gives you an immediate source of cash, you’re also giving up some control. Plus, this process takes longer than with an option such as invoice financing, where you’re simply borrowing against your invoices.

Alternatives to Invoice Factoring

Invoice factoring is a great financing solution for businesses with B2B and B2G invoices due within 90 days. However, it may not be the right solution for every business. The most natural alternative to invoice factoring is invoice financing. Other potential alternatives include a small business line of credit and a small business credit card. We’ll touch on those first, then compare invoice financing with invoice factoring.

Some common alternatives to invoice factoring are:

Small Business Line of Credit

As an alternative to invoice factoring, a small business line of credit (LOC) allows you to make advances against a pre-established credit limit. An advantage to this is you only pay interest on the amount advanced. This is a great alternative to invoice factoring if you’re only looking to bridge a small short-term need and if you have good credit. Some of the best small business lines of credit can even provide you funding in as little as one to two days.

Invoice Financing

An alternative to invoice factoring, invoice financing (aka accounts receivable financing or AR financing) is a technology-based financing solution. It 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 Factoring Frequently Asked Questions (FAQs)

Do I have to give up customer control with invoice financing?

With invoice factoring, you typically need to give up some of your customer control to your invoice factoring provider. This is not typically the case with invoice financing. With invoice financing, your relationship with your customers typically remains unchanged. You’ll continue to bill and collect your invoices just like normal.

How do businesses qualify for invoice factoring?

Unlike most short-term financing, which is based on the creditworthiness of your business, qualifying for invoice factoring has little to do with you. Since repayment is based on your customers paying their invoices, the ability of your customers to repay is typically the most important. The creditworthiness of your customers matters more than your credit.

What does a factoring company do if my customers don’t pay their invoices?

What happens in the event your customers don’t pay their invoices depends on the arrangement you’ve made with your invoice factoring company. With non-recourse factoring, the factoring company is responsible if invoices aren’t paid because your customer filed for bankruptcy or is otherwise insolvent. It’s important to read your contract closely to understand your responsibilities.

Will I be required to factor all of my invoices?

The arrangement you’ve made with your invoice factoring company determines if you have to factor all your invoices. With spot factoring, you get to pick and choose the invoices you sell to the factor. Contract factoring, which is more common, requires a minimum monthly volume or sets requirements on which invoices you have to sell.

Bottom Line

Factoring financing can seem more difficult than getting a loan from a bank. However, what makes factoring financing 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.

BlueVine is one of the best and fastest invoice factoring companies for small businesses. It offers low starting rates of 0.25%, funding up to $5 million, and an online application that business owners can complete in minutes. The fastest way to factor invoices is with BlueVine, and business owners open factoring facilities with the company every day.

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