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Factoring is the sale of pending invoices at a discount to a third-party financing company — called a factoring company — or to a bank. It is also known as accounts receivable factoring (A/R factoring), or invoice factoring. It is a fast and efficient way to obtain working capital that can be used for fueling growth, taking advantage of bulk discounts when purchasing supplies or making an investment in a large project. Faster and more flexible than bank financing, factoring requires little paperwork and can be accomplished in as little as 24 to 48 hours. Factoring relies on the creditworthiness of a business’s client, not the business’s own creditworthiness, making it an ideal tool for newer companies that work with larger, more established clients and might not have access to traditional bank financing.
- The business gives the factor a copy of the invoice that was sent to the client.
- The factor verifies the invoice and runs a credit check on the client.
- The factor advances a portion of the amount of the invoice to the business.
- Once the invoice is paid, the factor subtracts the discount and any additional fees and sends the remainder to the business. The discount and fees are the cost of factoring.
Non-recourse factoring occurs when a factor buys invoices outright. This protects the business from the risk of having to write off the invoice if it doesn’t get paid. If the client who is supposed to pay the invoice files for bankruptcy or becomes insolvent, the factor absorbs the loss. Before buying invoices, factors do due diligence on the business’s clients (referred to as “account debtors”). This gives the business information about its clients’ credit profiles and helps it decide whether to continue doing business with them.
As outlined on our Invoice Factoring page, factoring may make sense for your business for many reasons:
- Your business is working with a large client that commands longer net terms or has several clients that are taking longer to pay. The slow turnover may cause you to delay making important investments necessary to grow your business, hire staff, pursue new clients or buy the equipment needed to complete another client’s order on time.
- Your business is taking on debt to fund expenses or having cash flow problems while waiting for invoices to be paid. Unlike loans, factoring does not increase the amount of your business’s debt.
- Your business is spending too much time on invoicing and collections. Factoring companies can take over accounts receivable management.
A business looking to dip its toes into factoring may sell just one or two invoices to a factor in a transaction known as spot factoring. Spot factoring—also referred to as single-invoice factoring or single-invoice financing—is advantageous because it does not require a long-term commitment and allows the business to choose how many invoices it sells to a factor. However, invoices cannot be past due as factors are not equipped to act as collection agencies. But, as you factor invoices, Business Factors runs a credit check on your clients, allowing you to make informed decisions about continuing the business relationship.
In contrast to spot factoring, whole-ledger or full-turn factoring involves the sale of all the business’s invoices.
Business Factors does not have either a minimum for spot factoring or a monthly minimum for ongoing arrangements. To get started, fill out a one-page application or contact one of our executives today.
In recourse factoring, a factor agrees to extend funds against invoices for a short term. If, after that specified period of time, the factor has not been able to collect on the invoice, it goes back to the business. The business can choose to pay back the money advanced by the factor or replace the invoice with a new one.
Business Factors provides non-recourse factoring, where we purchase a business’s receivables and do not charge them back to the business if we are unable to collect.
To qualify for factoring, a business must have creditworthy clients. The factor runs a credit check on the business’s clients (called “account debtors” by factors) to confirm their creditworthiness. Also, the invoices that are to be factored must be free and clear of any liens, whether held by a lender, the IRS the Canada Revenue Agency. To make it easier to get approval for factoring or for another working-capital facility that relies on invoices (asset-based lending, for example), businesses should use straightforward billing arrangements and make invoices hard to dispute. Progress, contingency billing or consignment sales make it harder to obtain working capital using invoices.
If the invoices are pledged to someone else, a loan might be a better alternative. Business Factors offers revenue-based, asset-based and working capital loans, among other options. Contact one of our executives today to find the best working capital alternative for your business.
Any factor buying invoices will do at least some basic due diligence on both the business and its clients. Documents required to factor invoices vary by factor.
For smaller transactions (up to $250,000 of utilization), Business Factors generally asks for the invoices, a completed application, licenses and permits required to run the particular business, as well as accounts receivable and accounts payable aging schedules. Licenses and permits needed vary by industry and state and could include a certificate of liability insurance, operating authority for trucking and freight businesses, or workers’ compensation coverage either in the U.S. or Canada.
For accounts larger than $250,000, we may ask for financial statements, articles and/or certificate of incorporation and proof of the completed work (timesheets, work tickets, purchase orders, contracts, etc.).
Spot factoring in particular and smaller transactions ($10,000 to $250,000) can take as little as 24 to 48 hours, especially if the client needs working capital right away. But, generally, account setup for new deals from $10,000 to $250,000 takes between two days to a week, while the processing of midsize deals of $250,000 to $3 million takes a couple of weeks. Deals larger than $3 million can take a month or more because of the required due diligence. There are, of course, exceptions to this rule and situations where a million-dollar deal can get funded in a week and smaller deals can take longer than expected. If you are in a cash crunch, contact one of our executives today to learn more about the best working capital option for your business.
- Non-recourse factoring, meaning that we absorb the loss if the client does not pay
- Advances of up to 96% of the invoice face amount
- Fast, easy setup
- Over 20 years of experience in the freight, telecom, oil and gas, and payroll and staffing industries
- Low fees and complimentary credit checks on your clients
- Available 24/7, 365 days a year
- No upfront fees and simple credit qualifications
- Industry experience: more than $1.2 billion of invoices purchased annually
Business Factors can turn over the money in a way that is best for your business, be it a wire transfer, ACH or check. Please note that we cannot pay you directly in cash.
Factoring relies mostly on the credit history of a business’s clients, which makes it a good alternative for startups and businesses with a short or problematic credit history because of tax liens or a recent bankruptcy. The invoices that a business wants to factor, however, cannot be pledged to a lender or the tax authority. Business Factors routinely works with high-risk or seasonal businesses that do not qualify for a bank loan because they have little in the way of collateral or have a short credit history. Factoring can also be a great alternative for healthy businesses looking for a way to fund growth, cope with an unexpected increase in payroll commitments or smooth out uneven cash flow.
Yes, verifying invoices is a necessary part of the due diligence factors perform on the business and its clients. Due diligence is done by all types of financiers before extending funds to a business, so if your business has bank financing, it is likely that your invoices and other collateral are audited on a regular basis. If an institution offers your business money without due diligence, that should raise alarms. Such funds may come with provisions that can result in the business losing its assets without due process or paying exorbitant interest.
Most businesses are aware of factoring arrangements and understand that they are an efficient way to obtain working capital. Needing working capital is just a normal part of operating a business and it is unlikely to alter your relationship with the customer or its perception of your business.
Account debtors (the companies that owe money on the invoices) will usually get a notice that will tell them to send the payment to a lockbox owned by the factor.
Almost any business-to-business (B2B) or business-to-government (B2G) company is a good candidate for factoring. Business-to-consumer (B2C) companies are generally not good candidates because of the higher risk profile of their clients. Business Factors caters to a wide range of industries, including:
- Information technology
- Freight and trucking
- Government contractors
- Oil and gas
- Telecom, wi-fi and cable
The percentage of the invoice that factors advance is called the advance rate. Advance rates vary from 70% to 96% depending on the industry. An industry where invoices are likely to get disputed, such as retail, might have a lower advance rate than staffing or trucking where a disagreement about invoicing is less likely to occur.
The part of the invoice that is held back is called the reserve. Reserve is more likely to be used, for example, when a physical product is involved or when the account debtor (the client who is to pay the invoice) is located in another country. For more information about reserve, please see our Small Business Factoring page.
The discount rate is what a factor charges to turn your invoice into funds. Typical rates range from 1% to 5%.
For examples of factoring arrangements, please refer to our Invoice Factoring, Non-recourse Factoring or Small Business Factoring pages.
The discount rate depends on the profile of the business’s clients, the industry, the dollar amount of the invoices to be factored and their number, among other things. In addition to the discount rate, factors sometimes charge other fees, for example for due diligence or for a lockbox.
Let’s take a look at a couple of examples.
- Invoice amount: $10,000
- Advance rate: 90%, or $9,000
- Reserve: 10% or $1,000
- Fees: Monthly fee of 2.19%, or $219, every 30 days
- Type of arrangement: Non-recourse
In this scenario, the business pays $219 per month until the invoice is collected. If the invoice is collected after two months, the factor will charge $438 and return the remaining $657 to the business (the $1,000 reserve minus $438 in fees). If, for some reason, the factor is not able to collect on the invoice after five months, the business loses the reserve, but it does not pay anything else beyond that. If the factor cannot collect on the invoice at all, the business still gets to keep the advance. Please note that factors will not buy past due invoices and will run a credit check on the account debtor prior to advancing funds (as well as monitor payment trends thereafter).
- Invoice amount: $10,000
- Advance rate: 90%, or $9,000
- Reserve: 10%, or $1,000
- Fees: Weekly fee of 0.75% ($750), due diligence fee of $200
- Type of arrangement: Full recourse after 90 days
In this example, the business pays $219 per month to have the invoice factored. If the invoice is not collected within 90 days, however, the client must return the advance or replace the invoice with a new one.
Supply chain financing (SCF)—also known as reverse factoring—is the sale of a business’s invoices to a third party, such as a bank or a financing company. Unlike factoring, however, where sale of invoices is initiated by the business, supply chain financing is initiated by the party that will buy the invoices. Because of this, the fee for an SCF transaction—which is still covered by the business—might be lower than that for factoring.
However, businesses should carefully consider the terms of a reverse-factoring agreement. Some arrangements come with covenants that force the disclosure of proprietary information or require that the business factor all of their invoices with the SCF provider. In that case, factoring may be a better option because it allows the business to maintain control over its affairs.
Factoring is the purchase of an asset (accounts receivable), not a loan. As such, it does not increase the amount of the business’s debt and does not require a long-term commitment. A loan, on the other hand, increases the business’s debt burden and requires the payment of interest that can eat into a company’s cash flow for several years. SMEs may also have a harder time qualifying for loans that require collateral as well as numerous financial and legal documents. Factoring, on the other hand, relies on the credit history of the business’s clients and requires dramatically less paperwork.
Actually, it depends on the arrangement the business has with the factoring company. Fees for a recourse arrangement may be lower than for a non-recourse one, since the factor is taking on less risk. Additionally, fees and reserve rates may be lower for types of businesses that have a lower probability of invoices being disputed. These more reliable businesses include trucking or staffing companies, and they also normally have a higher advance rate than retailers, for example. For more details, see our Small Business Factoring page.
Unlike banks, factors typically do not place restrictions on the use of the proceeds from the factoring arrangement and do not require that the business restrict debt or acquisitions or maintain a certain level of financial performance. With Business Factors, you can get started in four minutes by filling out an application.
As outlined on our Asset-Based Lending (ABL) page, there are a few key differences:
- Ownership of the receivables. The principal difference between ABL and factoring lies in the ownership of the money due from the invoices. Unlike lenders, factors can take permanent or temporary ownership of these receivables, making them responsible for their collection. They can also provide additional services, such as invoice processing and credit checks on the business’s customers which can save the business time and money.
- Basis for the underwriting decision. Factoring mostly relies on the creditworthiness not of the business but of the business’s client. This makes it an ideal tool for newer companies that work with larger, more established clients but that might not have access to traditional bank financing. By comparison, asset-based lending underwriting decisions are made based on the payment history of both the business and its clients and the quality of the business’s other assets, such as inventory and, in some cases, equipment.
- Length of the commitment. Loans or revolvers are usually issued for several years. By comparison, factoring does not require a long-term commitment and can be relied upon to convert invoices into cash in 24 to 48 hours. Factoring one or two invoices is called spot factoring, while signing an agreement to sell all of the invoices is known as whole-ledger factoring.
- Flexibility. Factors can offer more flexibility to businesses because they are not bound by the restrictions that apply to banking. Factoring thus requires far less paperwork than taking out a loan and does not come with restrictions related to the use of funds, the business’s profitability, its acquisitions, and so on.
Revenue-based loans are loans extended on the basis of a company’s historical and expected revenue. Like factoring, they are good for businesses that are light on assets. However, the focus of factoring is primarily external, as it relies on the credit quality of a business’s clients, while revenue-based lenders take into consideration the financial situation of the business itself.
The repayment mechanism also differs. Revenue-based loans can be repaid using a percentage of a business’s revenue, in fixed installments or upon the maturity of the loan. Non-recourse factoring is an outright purchase of invoices, so there is nothing to be “repaid.” Recourse factoring, on the other hand, is similar to a short-term loan: if the invoice is not paid by the client, the business that sold the invoice must repay the factor or furnish another invoice to replace the unpaid one.
Borrowers should be wary of revenue-based lenders that offer loans with daily withdrawals or that incorporate something called “confession of judgment” in the credit agreement. The former are hard to keep track of while the latter may result in a business losing all of its assets with no opportunity to object.
A merchant cash advance (MCA) is an advance against future debit and credit card sales that is repaid using a percentage of these sales. The repayment mechanism allows a business to better manage its cash flow since the amount taken out will fluctuate with the sales. MCAs may be more expensive than loans because they are not subject to the same regulations. Businesses wanting to use MCA should carefully read the provisions of the agreement to ensure it does not come with covenants that may hurt the business through daily withdrawals or a confession of judgment.
Factoring, on the other hand, is the sale of receivables to a third-party financing company or a bank. Unlike MCA providers, factors are repaid when the business’s client pays the invoice. If the invoice is not paid, and the factoring arrangement is non-recourse, the factor must absorb the loss. In a recourse arrangement, the factor will ask the business to repay the advance or replace the invoice with a creditworthy one.
Business Factors offers non-recourse factoring.
They are not. Factors help businesses manage collections for the invoices on which they’ve made advances, but they cannot serve as a collector for defaulted invoices. Factors conduct a credit check on the client before agreeing to advance part of the invoice to minimize the risk of non-payment.
Factors can sometimes play that role for distressed companies with nowhere to turn, but most business owners can benefit from using the invoices that have been sitting around for months to help grow their businesses. In addition to collecting invoices, factors can offer other back-office services, such as invoice preparation and processing.
Straightforward billing terms, such as billing the clients by day, hour, week or work tickets are best. Progress or contingency billing, on the other hand, makes the process more difficult because the invoices created under either are easier to contest.
With offices in the U.S. and Canada, Business Factors provides a full range of services, including:
- Asset-based lending
- Accounts receivable financing
- Cash-flow loans
- Invoice factoring
- Revenue-based loans
- Working capital loans
- Purchase order financing
Business Factors & Finance also facilitates the following: bridge and term loans, import and export financing, purchase order and supply chain financing, and equipment purchasing and leasing. Services are available 24/7, 365 days a year.
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