Waiting to get paid is one of the biggest frustrations for business owners, especially those who have to wait for 30, 60, or 90 days before payment arrives. These long or late payment cycles can lead to serious cash flow constraints, causing business owners to fall behind on important expenses, such as inventory or payroll, or force them to pass up opportunities to take on new customers or expand to a new location.
Enter Invoice Factoring, a form of financing that lets small and medium businesses get cash advances on their accounts receivables. Instead of waiting weeks to receive payments on invoices, small and medium-sized businesses get paid quicker, allowing them to use the funds they’ve already earned to run and grow their business.
Here’s our step-by-step guide for choosing the right invoice factoring company for your business.
- What is Invoice Factoring?
- How Do Factoring Companies Work?
- Factoring Advantages and Disadvantages
- How to Choose a Factoring Company
- Are You a Fit for Invoice Factoring?
What is Invoice Factoring?
Invoice factoring is a financial transaction in which a business sells its accounts receivables (invoices) at a discount to an external financing company, known as a factor or factoring company. Factoring companies typically advance 70-90 percent of the invoice value up front. The remaining balance is remitted when the invoice is paid minus a fee.
Invoice factoring is also referred to as accounts receivable factoring, or ‘invoice financing.’ However, with some forms of invoice financing, a business owner secures a short-term loan using the unpaid invoices as collateral.
How do factoring companies work?
The factoring process first starts with the business owner, who decides which factoring company to work with. After the factor agrees to work with the business owner, the business owner can then start selling their outstanding invoices for working capital. When the factoring company verifies the invoice, the factor pays the business owner 70 to 90 percent of the invoice. Once the business owner’s customer eventually pays the invoice, the factoring company pays the business owner the remainder of the invoice minus a fee.
There are usually three parties involved in a factoring transaction:
- Your business (invoice issuer)
- Your business’ customer (who owes payment on the invoice)
- The factoring company (who supplies the cash)
Factoring process step-by-step:
- After a company delivers the product or service to their customer, they issue an invoice with net terms.
- The company then “sells” the invoice to the factoring company.
- In return, the company receives an advance payment, typically between 70-90% of the value of the invoice.
- With the cash on hand, the company can take on more work, pay employees or buy materials, supplies, and inventory.
- After the customer pays the outstanding invoice, the business receives a “rebate” for the remainder of the funds, minus a fee that is based on the term and value of the invoice.
- In the end, all three parties benefit: the customer gets cash upfront, their customer gets favorable payment terms, and the factoring company collects a fee.
Invoice factoring advantages and disadvantages
Factoring provides many benefits for B2B companies with outstanding receivables. But there are also disadvantages, particularly for certain industries or types of businesses.
Pros | Advantages
- Get quick access to working capital
- Offer flexible and longer net terms to your clients without worry
- Receive higher credit limits based on your clients’ creditworthiness, not just your business income and FICO
Cons | Disadvantages
- Not available to B2C companies or companies without notable, larger clients
- More expensive than traditional bank financing
- Potential liability for overdue invoices
Choosing the best factoring company for your business
Getting working capital is essential for small businesses to operate and overcome cash flow gaps. But equally as important is making an informed decision about which financing provider you decide to partner with.
To help you better understand what type of factoring company is right for you, here are 8 questions to ask in your search for the best invoice factoring company for your business.
What types of factoring services do they offer?
In choosing an invoice factoring company, you should consider the type of service you need for your business. Do you want to factor all of your invoices or do you want to be able to choose which invoices to submit for funding? Are you willing to take on risk in case a customer fails to make payment on an invoice?
Here are the key factoring terms and options that you need to be aware of:
Spot factoring vs. Whole Ledger Factoring
- Spot Factoring: Spot Factoring allows you to factor a single invoice on a one-time basis without long-term contracts, which allows for more flexibility. However, fees tend to be higher with spot factoring.
- Whole Ledger Factoring: With Whole Ledger Factoring, also known as Full Turn Factoring, a business is required to submit all client invoices. Rates are generally lower than spot factoring, but most whole ledger factors will charge a hefty termination fee if you decide to cancel your contract with them.
Recourse vs. Non-recourse
- Recourse: With recourse factoring, business owners take on the risk if their customer fails to pay the invoice on time. If your customer does not pay back the invoice that you submitted to the factoring company, you must cover the costs and purchase back the invoice from the factor. Recourse factoring is less risky for the factor and is generally a more affordable option than non-recourse factoring.
- Non-Recourse: With non-recourse factoring, business owners will not be liable if their customers fail to pay the outstanding invoice. However, the fees tend to be higher because the factoring company takes on more risk. Additionally, most non-recourse factors will avoid accepting invoices from your customers who have low credit scores and poor payment history.
Factoring vs. Invoice Financing
- Invoice factoring: Invoice Factoring is the selling of a business’s accounts receivables at a discount to a factoring company in return for a cash advance. The amount of the advance is typically 70 to 90 percent of the sold invoice. Unlike traditional bank financing, factoring provides more flexibility because the cash you receive is dependent on the invoices you submit and is technically a debt-free source of financing.
- Invoice financing: With Invoice Financing, business owners don’t sell their accounts receivables to the factoring company. Instead, the business owners use their accounts receivables as collateral to qualify for a loan. The amount of the loan depends on the strength of your invoices. There’s more risk for a small business with invoice financing because the invoices are still under the business owner’s ownership.
What terms and rates do they offer?
The fee rate structures for factoring companies ranges are either variable or flat. As a general rule, the more invoices you factor, the lower your rate will be.
With variable fee structures, also known as tiered fee structures, factors will discount a small percentage of the invoice for as long as the invoice is outstanding. This means the longer your invoice goes unpaid the more fees you’ll accrue over time. Although variable fee structures are more complicated to calculate, they can be more cost effective depending on the profile of your business, because the rate is based on the risk of the account
With a flat fee structure, the rate stays the same no matter how overdue the invoice is. However, flat rate fees are generally higher than the variable fee structures. Flat rate fees are calculated by multiplying the face value of an invoice with the flat fee.
That’s why if you have many clients that consistently pay well before their net terms, it is more cost-effective to use a flat rate fee structure than a variable fee structure. Otherwise if you plan on invoicing occasionally, flat fee structures make the most sense. It’s also important to note that flat fee structures are more commonly used for businesses in the transportation industry for ease of accounting.
Factoring terms and rates are determined by a number of factors, including, but not limited to:
- Business Industry
- Volume of invoices
- Net terms of the invoice
- Type of service
- Quality of clients
What industries do factors work with?
B2B businesses with notable clients and longer net terms are great candidates for accounts receivable factoring. Businesses in these industries are heavy users of factoring:
- Staffing services
- Freelancers (i.e. marketing, PR & creative)
- IT services and software development
- Commercial services
- Oil and Gas service Companies
Are there hidden costs or fees?
Some invoice financing companies have hidden fees or penalties. Know what triggers the penalties so you can avoid them.
- Termination Fees: If you sign a long-term contract with a factor and decide to cancel it, you may have to pay a sizable cancellation fee. Cancellation fees can range from 3% to 10% of your factoring credit line.
- Monthly Minimum Fees: Some factors require businesses to commit to factoring a certain amount of invoices per month. If a business fails to factor enough invoices, the factoring company will charge an additional fee.
- Maintenance Fees: This fee is charged to keep your account open/current with the factoring company. Maintenance fees are usually charged on a monthly basis.
- Due Diligence Fees: Charged whenever the factor needs to verify the background of your client. The factor will make sure that your client doesn’t have any existing liens, is in good credit standing, unpaid taxes, and more. Due diligence fees can cost you anywhere from a few hundred to a couple thousand dollars.
What’s in the factoring agreement?
The invoice factoring agreement is a financial contract that explains the costs and terms of your factoring plan. It includes complex terms and provisions, so It is important for you to study and understand an agreement before signing.
Double-check the rates and the terminology used such as minimum annual commission or customer limit. Keep in mind that some factoring agreements impose high (and sometimes outrageous) cancellation fees. Long-term contracts also may require you to factor a certain number of invoices.
What’s the factor’s advance rate?
An “advance” rate is the percent of the invoice face value that you’ll receive upfront. A fair advance rate is 70-90% of the face value of the invoice. For example, if your customer owes you $1,000, you should expect to receive a cash advance payment of $700 to 900 to your account.
How quickly can you get funds?
Some factoring companies (traditional factors especially) can take months to set up your business account whereas modern solutions, like Bluevine, can get your account set up in less than 10 days, and once your account is set up, can get you funds in hours. Online financing companies have made due diligence more efficient by through automation. What this means is that modern factors are now able to verify your customers, your invoices, and any existing liens on your business faster and more efficiently. Most modern factors can have the funds deposited in your bank account within hours after an invoice submission once your account is fully created.
Do they offer good service?
Depending on the complexity of your business, it’s likely that you’ll want to speak to a financing advisor who can facilitate inquiries before, during and after your application. Whether you choose to work with an online or traditional factor, make sure you’re assigned a real person on the other side to help navigate unexpected challenges and make sure you’re getting the appropriate amount of funds for your business.
Are you a good fit for invoice factoring?
Think about how important each of these questions is for your business and look for an invoice factoring company that will provide you and your business with the optimal combination of features, flexibility, and terms that you deserve. With a little research, you’ll find a partner and arrangement that offers you the funds, flexibility, transparency, and terms that work for you. As a guiding principle, look for a partner you’ll want to work with long-term and don’t settle for anything less.
Bluevine offers a streamlined approach to invoice factoring
Bluevine specializes in online invoice financing for business owners who want flexibility, speed, and transparent rates and terms. We offer spot factoring up to $5 million, and with our easy to navigate dashboard, you’ll be able to receive funds in as fast as one business day.
If you’re interested in learning more about invoice financing, give us a call with any questions at 1 (888) 452-7805.