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How Does Invoice Factoring Work?
- Business sell invoices to a factoring company (the factor) at a discounted rate
- The factor advances a lump sum up to 95% of the value of the invoice
- The factor then collects all payments directly from the client
- The factor sends the remaining balance to the business, minus any fees, which is typically an agreed-upon percentage
Invoice Financing and Invoice Factoring: What’s the Difference?
The main difference between invoice factoring and invoice financing is which party is responsible for collecting on the unpaid invoices. With invoice financing, the customer retains full control of collections. In invoice factoring, the factoring company purchases the unpaid invoices and takes over the collections process.
After submitting your invoices to the lender for invoice financing, you’ll receive the amount of the invoice minus a percentage as payment. Once the client pays you, you satisfy the agreement with the lender. While it may be helpful having the lender collect unpaid invoices on your behalf, understand that you will have less control over the collections process and that your clients may become aware of your cash flow shortages.
How to Apply for Invoice Factoring
Factoring companies typically calculate discounting rates using a variable fee structure where the factoring company charges a flat fee for the first 30 days, plus a small additional fee for every 10 days that the invoice remains unpaid. Other factoring companies offer a flat fee structure where a one-time fee is charged upfront and remains the same regardless of how long the invoice remains open. Late fees can add up so be sure to check your customers’ payment histories when choosing which fee structure is best suited for your business.
Invoice Factoring: Advantages and Disadvantages
FAQs About Invoice Factoring
What does it mean to factor an invoice?
Factoring an invoice means selling it to a lender in return for a discounted advance. Then, the lender collects the unpaid invoice from your customers on your behalf.
Is invoice factoring a loan?
Invoice factoring is not a loan. Factoring allows you to release untapped working capital from your accounts receivable to meet your immediate cash needs.
What is the difference between invoice factoring and invoice discounting?
Invoice factoring is when a business sells its invoices to a third party and then the factoring company controls the sales ledger and collects the debts. Invoice discounting allows you to draw money against your invoices, however, the business maintains control over the administration of your sales ledger.