How Invoice Factoring Works in 5 Steps (+ Rates and Fees & Choosing the Right Provider)

Invoice factoring is one way to receive funds quickly when your business faces a cash flow crunch. Businesses that invoice other businesses or government entities can assign any unpaid invoices to a factoring company. The factoring company will offer your business an advance of approximately 80% of your invoice upfront. Your business’s customer repays the factoring company, which distributes the remainder of the invoice, minus fees, back to you.

Infographic showing 5 Steps of Invoice Factoring.

Small businesses that need to factor invoices of up to $5 million will benefit from FundThrough. FundThrough offers a fast application and invoice assignment process that can sync seamlessly with your QuickBooks account. The FundThrough application process is simple and entirely online.

Visit FundThrough

1. Invoice Your Client

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

2. Sell & Assign the Invoice to a Factoring Company

Prior to receiving invoice factoring financing, you will need to find a provider you want to work with and go through the application process. The factoring company will determine if you meet its eligibility criteria to receive financing. It’ll also conduct due diligence on your invoiced customers to see if they’re good credit risks.

If the factoring company approves your business based on its research, it will enter into an agreement with you. The agreement will set an initial maximum dollar amount that you can borrow and will list fees and service charges that will apply. One of these fees, the discount rate, is determined in part by the creditworthiness of your customers. It’s best to use customers with good payment history for invoice factoring when possible.

3. Factoring Company Issues an Advance on the Invoice

After submitting your invoices, the factoring company gives you an initial advance based on the agreed-upon advance rate. On average, the advance rate is 80% of the value of the invoice, also known as the borrowing base. The advanced amount will depend on the size of your transaction, your industry, and other risk parameters.

The factoring company may also send a “notice of assignment” to your invoiced clients. The notice states that your business has assigned the factoring company as the entity to receive future payments for invoices you issue. All payments will go to a designated lockbox account, which is set up by the factoring company.

Some industries are more accustomed to invoice factoring than others. Trucking and shipping companies often use freight factoring. Factoring is also common in construction. In these industries, 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. Your Client Pays the Factoring Company

Your client will pay the factoring company according to the terms of the invoice. The factoring company will handle the collection on all invoices you assign to it, as governed by the Federal Assignment of Claims Act. It’ll try to follow your history of collection techniques unless the client is past due.

5. Factoring Company Remits the Remainder, Minus Fees

After receiving payment from your client, the factoring company will give you the remaining balance of the invoice, called the reserve amount, minus its fees. If your advance rate was 80% with a monthly factor rate of 3% and your customer repaid within 30 days, the factoring company pays you the remaining 17%.

Invoice Factoring Terms, Rates & Fees

Invoice factoring is a good working capital solution for businesses of varying sizes and ages, as long as your business has qualifying invoices. You can qualify for invoice factoring if you have invoices due within 90 days and have no serious tax or legal problems. Some factoring companies will work with startups, while others will require at least three months of business operations.

Qualifying for invoice factoring is often easier than qualifying for long-term financing. If you have B2B or B2G invoices due within 90 days and no recent tax or legal issues, you typically will qualify. While credit scores and debt service coverage ratios (DSCRs) can be significant hurdles for other types of financing, they’re less often issues with invoice factoring. Some factoring providers don’t even check your credit score.

Click through the tabs below for more information.

Amount You Can Borrow	$5,000 to $20 million per month
Invoice	Payable within 90 days and free of all liens
Time in Business	Varies by factoring company
Additional Qualifications	Invoice B2B or B2G customers No serious legal or tax problems Consistent on-time paying customers
Paperwork Requirements	Standard personal & business information Accounts receivable (A/R) aging report Accounts payable (A/P) aging report Tax returns (personal & business) Corporate paperwork
Discount Rate	0.5% to 5%
Expected Annual Percentage Rate (APR)	28% to 70%
Advance Rate	65% to 95%
Other Fees	Varies by factoring company

To qualify, most factoring companies consider:

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 factoring company will need to feel comfortable that your customers are likely to pay off your invoice.
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.
Tax and legal history: Your business should not have a history of serious tax or legal problems.

There may be other requirements for your business, such as a minimum credit score, but these requirements are usually far less stringent than they are with other lenders. Comparing the qualification requirements of the leading invoice factoring companies can help you decide which factoring company is best for your business.

The base cost 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 factoring company 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 will have a tiered system for discount rates, so the more you factor invoices in a month, the lower your rate can be.
Time it takes your customer to pay: Discount rates are charged at regular intervals―usually weekly or monthly―so the time it takes for the customer to pay your invoice will determine your cost.

Example of invoice factoring costs: Assume you factor a $100,000 invoice at an advance rate of 80% and a discount rate of 3% per month. In our example, you would receive $80,000 upfront. If your client makes full payment on the invoice within 30 days, the factoring company keeps their discount rate fee of $3,000 and will pay you the remaining $17,000 you are due. The total amount you receive is $97,000.

Besides the discount rate, there are other fees that you may encounter. These fees will vary from company to company. Read your agreement carefully to know what you may get charged and how much those fees are.

Some fees you may encounter with invoice factoring include:

Origination fees: These are upfront costs associated with starting 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 as an invoice ages. This fee can be as high as 1%.
Service fee or lockbox fee: This is a flat fee that is charged to keep a lockbox―a designated account for the factored invoices to be paid to―open. This lockbox fee can range from $50 to $500 per month.
Collection of overdue fees: The factoring company may charge you for its efforts required to collect past due payments from your customers. These fees vary and could range from nothing to a few thousand dollars.
Unused line fee: This is 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: If you don’t generate a certain level of fees for your factored invoices in a given month, the factoring company may charge you a fee as high as $1,000.
Renewal fee: The renewal fee is an annual fee applied after every full year the line is open. This could be up to 1% of the factoring facility size.
Automated clearing house (ACH) transaction fee: This is a fee of up to $30 that is charged for every advance or disbursement issued to you.
Wire fee: This fee is charged if you request to receive a wire instead of an ACH. The charge can be as high as $50.
Credit check fees: These are small in comparison to the other fees, but these may be passed on to you for any credit checks performed on you or your customers.

If you are applying with multiple companies to see which one will offer you the best deal, compare the fees and discount rates that each one charges.

Choosing the Right Invoice Factoring Company

Invoice factoring is for businesses needing a consistent cash flow solution and businesses that have at least $25,000 of invoices per month to B2B or B2G customers. If you choose this option, be prepared to bring the factoring company in as a partner on your A/R management and collections processes.

There are several aspects to consider when selecting an invoice factoring provider. These aspects range from the level of contact from the factoring company to the type of factoring you wish to pursue.

Types of Invoice Factoring

Understanding the different types of invoice factoring you’ll run across as you research factoring companies is key in choosing the right one for your business needs. Those types include:

Recourse factoring: Factoring company collects directly from the business if it cannot collect from the account debtor
Nonrecourse factoring: Your business isn’t liable for unpaid invoices—only available to businesses with numerous invoices
Spot factoring: Common form of factoring for small businesses because business owners can factor specific invoices as needed
Contract factoring: A factoring agreement that sets a minimum monthly factoring amount to remain in good standing—less common with new factoring companies, but usually required for large financing agreements
Nonnotification factoring: Uncommon, but available—a factoring agreement that prevents the factoring company from communicating with clients
Debt factoring: Another term for invoice factoring, usually requiring the business to sell the entire batch of invoices for a particular debtor
Advance factoring: Common form of factoring where a part of the advance is given to the business, with the factoring company keeping some percentage
Maturity factoring: Entails the sale of invoices for a set value and rarely grants the business additional payments when the factoring company collects an invoice

Customer Contact With Factoring Company

One aspect of invoice factoring that may intimidate business owners is the level of contact between the factoring company and customers. This stems from the fact that your customer will make payments to a third party instead of to you. Some small business owners imagine hard-earned customers being contacted by a company they’ve never heard of and being hassled for payment.

While these concerns aren’t unfounded, they’re exaggerated. Yes, some factoring companies will want direct communication with your customers to verify invoices, verify the assignment of the invoice, and make payment arrangements. However, this is more common in industries where factoring is prevalent.

Some factoring companies create an arrangement where there’s far less 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 factoring company. Your customers are notified of the new account information for payment. If the factoring company contacts your customer, it presents itself as your billing department.

Recourse vs Nonrecourse Factoring

Recourse factoring can become problematic if you have already spent the money you were advanced. It’s best to only factor invoices on those customers who pay on time. Fees can continue to accrue until you or your delinquent customer pays the invoice, often creating a new cash flow problem. However, with nonrecourse factoring, even if your customer doesn’t pay the invoice on time, your business won’t be on the hook for it. If you’re interested in pursuing nonrecourse factoring, we have a list of recommended companies for you to consider.

Read your agreement carefully before you sign: Some firms advertise nonrecourse factoring but then list several reasons an invoice may be exempt from it. Others will offer partial recourse agreements. Read your entire contract carefully to understand what you’ll and won’t be responsible for if clients don’t pay the invoice or pay the invoice late.

Spot Factoring vs Contract Factoring

Although spot factoring may seem ideal for your business, many invoice factoring companies prefer not to factor in this way. 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 of at least $10,000 to be factored or requires factoring of every invoice to a specific customer.

Industry Familiarity

Factoring is an area in which industry familiarity matters. The industry you and your customers are in can affect your terms and costs. Some factoring companies specialize in providing financing to specific industries and may avoid other types of business.

Time to Get Funding

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

If you’re looking for an invoice factoring partner, consider FundThrough. FundThrough doesn’t directly interact with customers and doesn’t collect invoices on behalf of the business. It’ll factor invoices of up to $5 million per month.

Visit FundThrough

Pros & Cons of Invoice Factoring

There are several benefits associated with factoring financing. One is that there’s generally no minimum credit score requirement, as your customer’s creditworthiness is what matters to the factoring company. Also, it’s a fast way to receive cash, and your A/R will be handled by experts.

Conversely, the factoring company may have direct contact with your customers. The costs of factoring can be high if customers are slow in paying. Additionally, your invoices are sold to a third party, which can expose you to a blanket uniform commercial code (UCC) filing.


PROS	CONS
Creditworthiness of your customers is considered	Factoring company may communicate with your customers
You work with A/R experts	Fees and overall cost
A quick source of cash	Your invoices are sold

Bottom Line

Invoice factoring allows you to borrow money, based on your unpaid customer invoices, to meet your immediate cash flow needs. As long as your clients pay on time, the cost of factoring can be more affordable than other short-term business loan alternatives. Doing your homework on what factoring companies will require from you before you sign any agreement will help you make the best possible decision should you choose this option for financing.