Invoice Factoring For Small Businesses

Factoring is a form of financing that allows business owners to get advance cash on their invoices before they’re paid. This type of financing is not based primarily on the credit of the business owner. Instead, it is based on the credit-worthiness of the client to whom you’ve issued an invoice. Keep in mind, if you’re doing business with individuals as opposed to other companies, the chances of being able to factor invoices is seriously hampered.

To factor an invoice is to sell it to a lender in return for a discounted cash advance. The lender then collects the unpaid invoice from your customers on your behalf.

Unlike a traditional loan, invoice factoring allows you to access funding without taking on the burden of periodic fixed payments associated.

Invoice factoring and loans are two different types of financing. Unlike a traditional bank or business loan, factoring allows you to release untapped working capital from your accounts receivable to instantly improve your cash flow.

Invoice factoring is when a business sells its unpaid invoices to a third party, after which that third party (the factoring company) then controls the sales ledger and collects the debts.

Invoice discounting also allows you to draw money against your invoices, but in this case, your business maintains control over the administration of your sales ledger.

The main difference between invoice factoring and invoice financing is which party is responsible for collecting the unpaid invoices.

Invoice financing (also called accounts receivable financing): the customer retains full control of collections, not the financing company

Invoice factoring: the factoring company purchases the unpaid invoices and takes over the collections process

Invoice factoring: While it may be helpful to have 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, which could affect your customer service reputation

There are two main types of invoice factoring: recourse and non-recourse factoring.

Recourse factoring is the most common type of invoice factoring in the United States. It involves an agreement between businesses and invoice factoring companies (“factors”) that, in the event that the businesses’ customers do not pay their invoices, the businesses themselves will be responsible for compensating the factors.

With non-recourse factoring, the factors assume all of the risks; even if customers fail to pay, the business owners do not owe anything to the factors.

The fees depend on a variety of factors, such as the creditworthiness of your business and your clients, the number of invoices you plan on submitting for financing, and even the type of industry your business is in.

A typical factoring fee is, however, between 0.05% and 4%. Additional fees can include:

Monthly Minimum Fees
If a business produces less than ideal results after a credit check, factors may require that business to commit to submitting a minimum monthly invoicing amount or charge additional fees.

Maintenance Fees
Many factoring companies charge businesses a (usually monthly) fee to keep their accounts running and open.

Termination Fees
If a business owner signs a long-term contract and desires to terminate their invoice factoring agreement, there may be cancellation or termination fees, which will typically run a business a small percentage of their credit line.

Due Diligence Fees
Sometimes, a factor will check into the reliability of a business’ clients beyond face value (e.g., the clients’ creditworthiness, whether they have any liens against them, etc.). Each time the factor performs this check, it may charge the business a due diligence fee, which typically ranges in cost from a few hundred dollars to several thousand.