Invoice Factoring and Accounts Receivable Financing

Invoice Factoring and
Accounts Receivable Financing


Invoice factoring is a method of business financing in which a company sells or assigns its invoices or accounts receivable to a factoring company at a discount in exchange for immediate cash. Factoring improves cash flow because the company doesn’t have to wait 30, 45, 60 days or more for the collection of its accounts receivables.

Invoice factoring is commonly referred to as:

  • Accounts receivable factoring
  • Accounts receivables financing
  • Invoice financing
  • Invoice discounting

Factoring is not a loan as it doesn’t create debt or require you to make loan payments. Invoice factoring is not the same as bad debt collections because factoring companies don’t purchase past-due receivables. They may purchase receivables that become past-due, but factoring companies don’t buy past-due receivables.

“If you got paid for sales the instant you made them,
you would never have a cash flow problem.”

– Entrepreneur.com

Is Invoice Financing Right For You?


Determine if invoice financing is right for your business – point to the questions in the boxes below to see the answers. Find answers to questions regarding poor credit, factoring costs, business conditions, and best uses of factoring funds.

Poor Credit

Can I qualify for invoice factoring if I have poor personal credit?

Should I Factor?

Maybe... don't let poor credit stop you. Factoring companies focus more on your customers' credit.

Factoring Cost

Is invoice factoring too expensive for my business?

Should I Factor?

If the use of factoring generates more profit than it costs, then factoring is a good financial decision.

Growing Business

Is invoice factoring the right financial strategy to fund my growing business?

Should I Factor?

Factoring is an excellent financing tool for growing businesses, especially if you don't qualify for a traditional line of credit.

Seasonal Sales

Should I use invoice factoring to fund inventory or production costs resulting from seasonal spikes in sales?

Should I Factor?

Yes... factoring is an excellent financial tool for smoothing out seasonality in sales.

Debt Retirement

Should I use invoice factoring to pay off long-term debt or tax liens?

Should I Factor?

Cautiously... use only the profits of your business without impairing working capital. For large debts, set up an affordable installment plan.

Equipment Financing

Should I use invoice factoring to pay for equipment purchases?

Should I Factor?

Cautiously... use only the profits of your business without impairing working capital. For expensive equipment, you should get an equipment-based installment loan.

Invoice Financing vs Bank Financing

Your business needs cash for working capital – rather than borrow from a bank, you determine that receivables factoring is best for your business. Common reasons for choosing invoice financing versus bank loans include

  • You don’t have 2 to 3 years of profitability.
  • You have a new or start-up business.
  • The bank won’t lend sufficient funds for your growing business.
  • You can’t wait 2 or 3 months for a bank approval.

Invoice factoring is as effective as a bank line of credit and better than a traditional term loan. Factoring has the added benefit of managing itself as a working capital line of credit, as long as you spend the funds on operating expenses rather than equipment, long-term debt or family vacations.

The Accounts Receivable Factoring Process


Accounts Receivable Factoring Diagram shows how invoice factoring works.

Accounts receivable factoring generally occurs in six sequential steps. It begins with the completion of selling your product or service to the final step of receiving your final payment. Factoring companies may vary on whether they collect their factoring fees on the “front-end” or “back-end”. Front-end fees are paid below in step four. Back-end fees are paid at final payment in step six.

The Accounts Receivable Factoring Process Step-by-Step

Here’s a look at the entire accounts receivable factoring process:

  1. You complete the sale of goods or perform services for your customer.
  2. You send your invoices and and a list of the invoices (Schedule of Accounts or Assignment Sheet) to your factoring company.
  3. Factoring company verifies the sale of goods or the completed service, then forwards the invoices to your customers.
  4. Factoring company wires funds to your bank account, usually within 24 to 48 hours. They fund the invoice amount based on an advance rate. If the advance rate is 85% then the factoring company will send you 85% of the invoice and hold-back a reserve of 15% for possible bad debts.
  5. Factoring company collects the receivables and deducts charge-backs and factoring fees from the reserve. Charge-backs include short-payments, discounts, or other deductions.
  6. Factoring company sends you the available reserve as final payment.

This entire process is repeated for each invoice or batch of invoices that you factor. You may have invoices in various stages of the process. For instance, you will might submit new invoices while other invoices are still being collected. At any time, you can request reports that show your outstanding invoices, paid invoices, and past-due invoices.

Most factoring companies don’t require you to factor all your invoices. You can usually select only the customers that you want to factor, hence you have some flexibility on how much and which customers you decide to factor. Some factoring companies require you to factor all your invoices.

Accounts Receivable Financing Benefits


Accounts Receivable Factoring Cash Flow Diagram

Cash Flow

Accounts receivable financing improves your cash flow because you don’t have to wait 30, 45 or 60+ days to collect your receivables. You get the cash quicker so you can pay for supplies, payroll and other operating expenses.

Quick and Easy

In an age of slow-moving loan applications and tight bank regulations, accounts receivable financing is a quick and easy alternative to bank financing. Factoring your invoices can be approved and funded within a week or two.

Receivables Management

Factoring companies handle your accounts receivable management such as billing, collections and reporting. Factoring your receivables can often pay for itself in man-hours saved if you performed these in-house.

Credit Services

Factoring companies analyze your customers’ credit risk as well as credit limits so you don’t get over-extended with a customer. Sometimes factoring companies reduce credit risk by purchasing credit insurance for your receivables. All these credit measures and practices protect both you and the factoring company from potential bad debt losses.

Invoice Verification

Invoice verification is a valuable service that factoring companies perform to insure that your invoices are sufficiently documented so they get paid. This gives you more time to focus on your business, not billing details.

Internal Control

Many small businesses don’t have enough people to adequately separate the different cash functions to prevent employee theft. Invoice factoring provides internal control measures by having your factoring company control handle these functions.

Invoice Factoring Rates


Factoring rates are very specific to each business. This is why FactoringClub doesn’t quote rates in our factoring company listings. Factoring rates depend on several criteria such as sales volume, industry risk, customer risk and AR days outstanding. Rates can vary from 1% to 8% or more depending on your situation and the factoring company. Factoring rates are either flat or periodic. Use our factoring calculators to estimate your factoring costs.

SALES VOLUME

Higher Volume - Lower Rate

The higher your sales volume, the lower your invoice factoring rate. Factoring $500,000 sales per month has a lower rate than factoring $50,000 per month.

INDUSTRY RISK

Higher Risk - HIgher Rate

Some industries such as construction and medical receivables carry more risk. This is mainly due to the higher risk associated with their payment methods.

CUSTOMER CREDIT

Higher Credit - Lower Rate

The better your customers’ credit, the lower your invoice factoring rate. Factoring companies use your customers’ credit scores to determine your customers’ risk.

AR DAYS OUTSTANDING

Higher AR Days - Higher Rate

Factoring companies look at your average AR days outstanding. The higher your AR days, the higher your rate. Flat rates are best for high AR days and periodic rates are best for low AR days.

How to Determine Your Factoring Cost

Let’s look at a few cost scenarios so you can get an idea of invoice factoring costs. Let’s say your business needs to factor $100,000 of invoices with expected AR days outstanding of 45 days.

Factoring Company A charges a flat rate.

  • Factoring rate: flat rate of 3.5% on your invoices.
  • Factoring cost: $3,500
  • Effective rate: 3.5%

Factoring Company B charges a monthly rate (pro-rated).

  • Factoring rate: monthly rate of 2.0% on your invoices.
  • Factoring cost: $3,000
  • Effective rate: 3.0%

Factoring Company C charges a weekly rate (not pro-rated).

  • Factoring rate: weekly rate of 0.8% on your invoices.
  • Factoring cost: $5,600
  • Effective rate: 5.6%

As you can see, there is a large variation in costs. The costs for factoring companies A and B are comparable, except that the flat rate is going to protect you if your AR days exceed 45 days. Company A or Company B are your best choices depending on your AR days outstanding. Avoid Company C!

The Invoice Factoring Application


All invoice factoring approvals follow the same general process. First, you complete the application and submit related documents. Second, the factoring company performs underwriting to qualify your business. Third, you sign the factoring agreement and other forms.

The approval process can take anywhere from a couple days to two or three weeks, depending on your situation and the factoring company.

Application

A typical factoring application requires a list of your customers, an AR aging, and recent financial statements.

Underwriting

Factoring companies check your business for any asset liens and tax liens. They also check you and your customers’ credit.

Agreement

In addition to the factoring agreement, the factoring company may require a personal guarantee or power of attorney.

UCC Filing

After approval, the factoring company files a UCC-1 financing statement on your business’s accounts receivables.

Choosing a Factoring Company


Never settle for the first factoring company you see in a Google search or factoring article. Do your homework and research before selecting a factoring company. Your best resource to search for factoring companies is FactoringClub.com, as we have complete information on over 100 factoring companies. FactoringClub also provides free consulting services.

Industry

Oil and Gas factoring

In addition to finding a factoring partner who will work with you and provide exceptional customer service, you also want to find a factoring company that provides factoring services in your industry. Although accounts receivable financing is pretty standard, some industries that require factoring expertise:

If you conduct business in one of these industries then you need to find an invoice factoring company that has experience with your industry. Just like you would want to find a dermatologist to take care of your skin problems or a podiatrist to take a look at your foot problems, finding a factoring specialist ensures you get the best possible factoring service.

Interest and Knowledge

Invoice Factoring Company Partner

When talking to a factoring company representative, gauge the attitude, helpfulness and transparency of the company representative. When talking to the company rep, ask yourself the following questions:

  1. Is the sales person really interested in my business?
  2. Does the person answer my questions knowledgeably and clearly?
  3. Is the person transparent and easy to understand?

Find who will be your contact person after the sales process on customer service issues. You want to have someone within the factoring company responsible for handling your concerns and not be passed around like a hot potato.

Factoring Rates

Progress Billing

A factoring company should give you a ball-park estimate of your factoring cost based on the following:

  1. Your factoring volume.
  2. Your AR days outstanding.
  3. Your customers’ credit-worthiness.

Some factoring companies calculate costs on a periodic (weekly, monthly or daily) basis while others charge a flat fee. Flat fees are good if your AR days outstanding are high, while periodic rates are good if your AR days are low.

Credit Size

All accounts receivable factoring companies have minimum and maximum credit limits (or credit facilities). When searching for a factoring company, see that your funding needs are within the factoring company’s credit limits.

If you need…

$2,000,000 – look for a factoring company that provides factoring services for $2,000,000 and higher (give yourself room to grow).

$25,000 or less – look for a micro-factoring company.

Contract Terms

Spot factoring

Setup fees, due diligence fees, credit check fees, invoice processing fees and other fees can add-up quickly. Many factoring companies don’t charge setup or application fees. Some factoring companies charge a monthly minimum fee if you don’t meet a minimum invoice amount per month.

Some factoring companies require a long-term contract (more than one year) and expensive cancellation fees. Some factoring companies only required 30 days notice.

Office Location

Factoring Companies Map

If you want a face-to-face relationship, then look for a factoring company in your area. If you’re business is in a special industry or you have unique factoring needs, then you’ll need to perform a nationwide search. It’s common for businesses to use a factoring company in another part of the country.

Finding the right factoring company for your business requires some time. It’s time well spent as you can save both time and trouble for your efforts. FactoringClub gives you the information you need to save time and make a well-informed decision