What Is Invoice Factoring?

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.

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.