Is Invoice Factoring Right For Your Small Business?
If your business, like many others, has outstanding invoices and slow-paying customers, you don’t have to be stuck without cash flow. Invoice factoring — selling unpaid invoices to a factoring company in exchange for immediate cash — could be the answer to your troubles. But how exactly does invoice factoring work? Should you use small business factoring services? And if so, how do you choose a good factor? Keep reading to find out!
Table of Contents
Invoice Factoring Basics
Invoice factoring (or accounts receivable factoring) is when a business sells their unpaid invoices to a factoring company, at a discount, in exchange for immediate cash.
Factoring is generally used to solve cash flow problems caused by slow-paying customers. Instead of waiting 60, 90, or even 180 days for a customer to pay, small businesses can sell their invoices to a factoring company (also called a “factor”) to get the cash needed to maintain business operations or take on new projects.
But how does factoring actually work? Typically, the factoring company will give you 85% to 95% of the invoice total upfront and hold a percentage of the invoice value in reserve until the customer has paid the invoice; when the customer pays, the company will send you the reserved money, minus a factoring fee. A normal factoring fee (or discount rate) ranges between 1% and 6% per month. Fees can be accrued daily, weekly, or monthly, so the longer your customer waits to pay, the larger your accrued factoring fee becomes.
Here is an example of what a typical factoring arrangement might look like:
You sell an invoice valued at $5,000 to a factoring company. The factoring company sends you $4,500 (90% of the invoice value) and keeps $500 on reserve. Your factoring fee is 0.6% per week. Your customer pays after 35 days (or 5 weeks), so your fee is $180 ($30 per week). The factor deducts their fee, and sends the remaining reserve, totaling $320, to you.
Make sense? While no one likes having to give up a percentage of their hard earned money, the immediate cash may be more than worth it.
Recourse VS Non-Recourse Factoring
Invoice factoring may sound great, but what happens if your customer doesn’t pay their invoice? Well, it depends on whether you have a recourse or non-recourse factoring arrangement:
- Recourse: You are entirely responsible for re-purchasing the unpaid invoice.
- Non-recourse: The invoice factor is responsible for the unpaid invoice.
Note: Most often, non-recourse factoring only covers clients who declare bankruptcy. The factor may still hold you responsible for paying back disputed invoices.
Read Non-Recourse Invoice Factoring: Everything You Need to Know to learn more about the pros and cons of each option.
Spot Factoring VS Contract Factoring
In addition to recourse and non-recourse factoring, there’s also the option of spot factoring or contract factoring:
- Spot Factoring: Where you pick and choose which invoices you sell to a factor.
- Contract Factoring: Where you agree to a long-term contract to sell all (or most) of your invoices to a factor.
There are pros and cons to each option. Spot factoring enforces no long-term contracts or minimum volumes but does often involve higher factoring fees. With contract factoring, you’re locked into a factoring agreement and you often have to meet a minimum monthly volume, but you typically have lower factoring fees. Read Spot Factoring: Is Single Invoice Factoring Right For Your Business? to learn more.
Invoice Financing VS Invoice Factoring
|Invoice Financing||Invoice Factoring|
Uses invoices as collateral for a line of credit
Sell invoices for immediate cash
You are granted a credit facility based on the value of your unpaid invoices, and can draw from your available funds at any time
Factor gives you an advance when the invoice is sent and sends you the rest once the customer pays (minus a factoring fee)
You are responsible for collecting invoice payments
Factor is responsible for collecting invoice payments
Invoice factoring isn’t the only way to leverage your unpaid invoices to get funding. There’s also invoice financing.
Invoice financing is technically a catch-all term for any form of financing involving invoices. There are two main types of invoice financing: selling your invoices (invoice factoring) or using your invoices as collateral for securing a loan. Most often, when you hear the term “invoice financing,” people are referring to the latter. (You may hear the term accounts receivable financing instead.)
With invoice financing, instead of selling your invoices, you’ll use your accounts receivable (unpaid invoices) as collateral to qualify for an asset-backed line of credit. With an asset-backed line of credit, a financer will grant you a credit facility based on the value of your unpaid invoices.
One of the other major differences between invoice financing and invoice factoring is that with invoice financing you are in charge of collecting the payments from your customers. Conversely, an invoice factor has officially purchased the invoice, so they are responsible for collecting the customer payment — not you. While some factors may offer non-notification invoice factoring, most notify your customers that a third-party factor is collecting their payments.
Invoice factoring is becoming more and more common and is now considered standard for many industries; however, if you aren’t comfortable with a factor connecting directly with your customers and want more control over your invoicing, invoice financing may be a better solution for your business.
If you want to see the difference between invoice financing and invoice factoring in terms of borrower requirements, see the chart below. Fundbox is one of our highest-rated invoice financers and BlueVine is one of our top invoice factors. Here’s how they compare:
Time In Business
$50,000 per year
$120,000 per year
Minimum Credit Score
At least 2 months of compatible accounting/invoicing software use
Must run a B2B or B2G business
Here is how the top invoice financer and factor compare in terms of rates and fees:
Up to $100,000
Starts at 4.66%
0.25%-1% per week
Possible $15 wire transfer fee (no ACH transfer fee)
12 or 24 weeks
13 weeks (91 days)
Recourse Or Non-Recourse
Notification Or Non-Notification
Note that borrower requirements and rates will vary with each invoicing financing and invoice factoring company.
Are You Eligible For Invoice Factoring?
Now that you know the basics of invoice factoring and how it differs from invoice financing, the real question is: how do you know if you qualify for invoice factoring? If you run a B2B or B2G business and you invoice your customers, chances are you’re a good candidate for invoice factoring.
Unlike almost every other type of business financing, your business’s revenue and creditworthiness are not especially large considerations when determining eligibility. Invoice factors are more concerned with the creditworthiness of your customers because your customers are the ones actually paying the bills.
This makes invoice factoring a potential option even if:
- You have a new business without a financial track record
- You don’t make very much money
- You have poor personal credit
While these characteristics make it difficult to qualify for traditional business loans, you might still be eligible for invoice factoring based on the status of your accounts receivable.
Is Invoice Factoring Right For My Business?
You may be eligible for invoice factoring, but should you use a factoring service? There are a lot of pros to factoring your invoices, but it’s not a perfect fit for all businesses. To determine whether factoring is right for your situation, ask yourself these three questions:
1. Are my finances suffering due to slow-paying customers?
Slow-paying customers can affect many areas of your business. If you aren’t paid for your work until months after you have completed the job, you might have trouble managing business expenses, purchasing inventory and supplies, paying employees, or covering overhead costs. If this is the case, invoice factoring companies can be a simple way to ensure that you have the working capital you need to run your business.
However, invoice factoring is not always cheap, which is why you need to consider this next question.
2. Can I afford invoice factoring?
In general, factoring fees (or discount rates) range from about 1% – 6% of the invoice value per month, depending on your specific factoring arrangement. If you sell an invoice from a particularly slow-paying client, and you have a high factoring rate, you could wind up paying around 18% (or higher) of the invoice value in fees for the opportunity to get your money sooner.
Many invoice factors also charge additional fees for factoring services. Business owners might be charged:
- Money transfer fees
- Servicing fees
- Monthly minimums
- Renewal fees
These fees can start adding up quickly over time. Head over to our explanation of factoring rates and fees to learn about discount rates and other commonly charged fees.
All that said, your fees will depend on a number of components, including the factoring company you are working with, the creditworthiness of your customers, the number and size of the invoices you want to sell, the industry your business is in, and other considerations. You will have to look at your options and decide whether the cost is worth it to your business.
3. Would an alternative financing solution work better?
Even if you decide that you need a financial solution, invoice factors most likely aren’t your only option. Now, more than ever, businesses have a plethora of financial solutions available. While invoice factoring might seem like the perfect solution to your cash flow problems, the following loan products might be a better fit:
Asset-Backed Lines Of Credit
As we mentioned earlier, these credit lines can be backed by unpaid invoices or (occasionally) assets like inventory or other receivables. The amount you are able to borrow depends on the value of your collateral. Asset-backed lines of credit work similarly to invoice factoring but might offer more flexibility in some ways. These credit lines also tend to have lower rates than unsecured financing, so you might qualify for low rates and fees in comparison to other options.
Revolving Lines Of Credit
With a revolving line of credit, the amount you are able to borrow replenishes as you repay your debts. While some revolving lines of credit are backed by collateral, some simply require you to sign a personal guarantee and/or pledge general business assets via a blanket lien. With this type of financing, you’ll always have money available when you need it. And because you repay weekly or monthly, you don’t have to worry about getting fined because your customers forgot to pay their bills.
|Lender||Borrowing Amount||Draw Term||Draw Fee||APR||Next Steps|
|$6K-$100K||6 months||None||Starts at 13.99%||Apply Now|
|$5K-$5M||6 months||1.50% per draw||21% - 65%||Apply Now|
|$1K-$100K||12 weeks||None||12%-54%||Apply Now|
Business Credit Cards
Business credit cards can be useful for business owners who need cash for business expenses. You can put many purchases on credit cards and repay them on a timetable that works for you.
However — especially if you tend to carry a balance — you might want to consider other options because credit cards have notoriously high rates and fees. If you’re looking for a business credit card, check out some of our favorite business credit cards.
Small Business Loan
If you only need funds one time, or if you need a large sum of money, a small business loan might be a good bet.
Some lenders have long application processes, but many can let you know if you’re eligible within a very short time period, without affecting your credit score. Most small business loans come in the form of installment loans or short-term loans. Small business loans can be used for a number of purposes, such as working capital, payroll, inventory purchasing, and more. Check out these top-rated small business loan providers to see if you qualify for this type of funding.
If invoice factoring still seems like the right financing option for your business, great! Keep reading to learn how to choose the perfect invoice factor for your business.
How To Choose The Right Invoice Factor
Now that you’ve determined invoice factoring is right for you, the next step is choosing an invoice factoring service. But how do you know which invoice factoring company is best for your small business? The are many things to consider when selecting an invoice factor, including:
- The factoring fee
- Any additional fees
- Whether the factor is recourse vs. non-recourse
- Whether the factor is notification vs. non-notification
- Whether the factor requires a long-term contract
- Which invoices you can factor
A good invoice factoring service is going to vary depending on your business’s specific needs, so take the time to decide which qualities are most important for your business and find a factor that meets those requirements. Do your research and do some shopping around to find the best rates and fees available to you. Take a look at our top invoice factoring providers to get started.
Now you know what invoice factoring is, how it’s used, and how to tell if it’s right for you.
If invoice factoring sounds like a good solution for your business, great! Invoice factoring can help solve the problem of slow-paying customers and alleviate cash flow troubles. To find the right invoice factor for your business, take a look at these top invoice factoring services and start taking control of your cash flow today.
Merchant Maverick’s comprehensive reviews of invoice factoring services also provide honest and thorough assessments of some of the most popular invoice factoring services available.
If after reading this post, you’re still not sure if invoice factoring is right for you, the following resources can provide additional information about invoice factoring and may make your decision easier:
- A Basic Introduction To Invoice Factoring
- Understanding Invoice Factoring Rates & Fees
- Spot Factoring vs. Invoice Factoring
If you know that you need a cash flow solution but invoice factoring doesn’t sound like the right business move, don’t worry. We’re here to help! There are plenty of other ways to improve cash flow and other business funding options available. Check out our comprehensive small business loans reviews or let us find the perfect loan for you.