Invoice factoring is a type of financing that converts invoices due within 90 days into immediate cash for your small business. You submit an outstanding invoice to the factoring company, and it provides you with part of the invoice value for a small fee. It’s different than invoice discounting, which uses the invoices as collateral. It’s considered an alternative to other forms of financing like lines of credit and short-term loans.
How Invoice Factoring Works
In an invoice factoring transaction a business applies, the factoring company reviews the application and checks the debtors, and a contract is signed. This initial process can take from one to 10 days. On an ongoing basis, the business submits an invoice, the factoring company provides an advance, then it collects the invoice, deducts its fee, and pays the remainder to the business. This part of the process usually is done within 24 hours of an invoice being issued.
Evaluating Invoice Factoring Companies
Small business owners use invoice factoring to outsource receivables, collect invoice payments sooner, and address cash flow gaps. The practice of factoring is widespread, so factoring companies specialize in certain industries and solutions to provide the best possible customer experience. To evaluate an invoice factoring company, it’s important to assess the problem you are attempting to solve and to find the factoring company that’s most experienced in your industry.
How Invoice Discounting and Factoring Are Different
Small business owners looking for an invoice financing solution sometimes confuse invoice factoring with invoice discounting. Invoice factoring is different because the invoices are sold to the factoring company, and the factoring company handles the collection of the invoices directly. Invoice discounting relies on the invoices as collateral, but the collections process remains with the business, making it more similar to a business line of credit than a factoring solution.
Advantages of Invoice Factoring
- The creditworthiness of your customers is considered: With invoice factoring, your customer’s creditworthiness is more important than yours, meaning you’re able to get financing with poor credit.
- You get to work with accounts receivable experts: Since this is what your invoice factoring company does on a daily basis, it likely has really good accounts receivable management techniques.
- Invoice factoring provides a quick source of capital: You can typically get approved within two to seven days and funded in one to three days after that.
Disadvantages of Invoice Factoring
- The 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.
- It can be an expensive form of financing: 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.
- Your invoices are sold: A feature of invoice factoring is that you’re selling, or assigning, select invoices to the factoring company. While this gives you an immediate source of cash, you’re also giving up some control over your accounts receivables.
Alternatives to Invoice Factoring
Invoice factoring is not always an accessible solution for small businesses, and there is sometimes a more efficient invoice factoring alternative that a business can get. The nature of the financing problem will often determine the best alternative. For example, a business that only needs funding once in a while is better off with a business line of credit. On the other hand, a business that needs a large lump sum of funding is better off with a short-term business loan.
Bottom Line
Invoice factoring is a financing solution small businesses use to address cash-flow gaps. It works by exchanging an unpaid invoice for immediate payment with the cost of a small fee. Business owners considering this option should find a company that addresses their needs and has experience in their industry. If factoring ends up being the wrong solution or it’s less efficient than other financing then consider an invoice factoring alternative.
