What is invoice factoring and how does it work?
Invoice factoring is sometimes referred to as ‘factoring’, or ‘debt factoring’, is a financial product that enables businesses to sell unpaid invoices to a third-party factoring company (a factor).
Invoice factoring companies buy the invoices for a percentage of their total value and then takes responsibility for collecting the invoice payments. Factoring is a popular form of alternative business funding.
How does invoice factoring work?
Most factoring companies pay in two instalments, the first covering the bulk of the receivables and the remainder when your client settles their invoice, minus any factoring fee.
The invoice factoring breakdown is as follows:
- Once an invoice factoring agreement has been signed, the factor will advance you the money – a percentage of the invoice value which is usually 70-90%.
- The factor will then commence collection of the invoice with your customers.
- Once the invoice has been collected, the factor will pay you the remaining balance of your money, minus their fee.
Advantages of invoice factoring
- A quick source of cash flow by releasing working capital tied up in unpaid invoices.
- It can lower time spent on administration and chasing late payments since the factor assumes responsibility for collecting the debt.
- Invoice financing can provide better cash-flow control where there may be different credit terms across your clients and customers
Can any business use invoice factoring?
Invoice finance is just as effective for small businesses and start-ups as it is for larger companies. It can be ideal for brand new businesses, start-ups and even companies with poor credit, as a means of attaining finance more effectively. Though rates may be slightly higher, for less established businesses or those with bad credit.
How much does factoring invoices cost?
Invoice factoring costs differ depending on things like the value of invoices, the size of the company (small business factoring or factoring invoices for larger companies), and the level of risk for the funder.
What’s the difference between invoice factoring and discounting?
The key difference between invoice factoring and discounting is that while invoice discounting allows the business to retain control of its sales ledger and invoice collection, factoring gives the invoice finance provider that role.
Can I select certain invoices?
Yes. This type of financing is called selective invoice factoring, spot factoring or single invoice financing. This is where you can pick and choose which invoices you wish to factor by selling individually selected invoices, giving you the flexibility to choose the specific invoices that you factor.
Is invoice factoring a loan?
Factoring is not considered a loan, but a form of asset backed finance. Invoice finance providers will manage their own credit control and chase customers directly for the settlement of invoices.
Is invoice factoring right for my business?
If your business is struggling with cash flow issues and has a lot of unpaid invoices tied up, then Invoice factoring could be the right choice.
One of the problems for many businesses is that payment terms for invoices can be between 30 to 90 days, and this can lead to cash flow issues and gap in cash flow during this period is often filled by either bank overdrafts or business loans.
Where businesses have less than perfect credit scores, these options may not be available, so factoring can be a useful solution to this issue.