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What is spot factoring?
Factoring involves the sale of pending invoices to a factor, which is a financing company that specializes in such transactions. 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 for a large project. Faster and more flexible than bank financing, factoring requires little paperwork and can be obtained in as little as 24 to 48 hours.
Spot factoring – also known as single invoice financing or single invoice factoring – is a convenient way to monetize one or several invoices without signing a long-term agreement. This type of factoring is a great option for businesses that want to give factoring a try or need money in a pinch. It offers more flexibility than high-volume factoring – also known as whole ledger or full turn – which requires a company to factor all of their invoices.
How does factoring work?
Factoring relies on the creditworthiness of a company’s clients and the company’s own credit profile does not usually matter.
Factoring is generally a four-step process as described below:
- The business provides a factor with 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 outstanding amount
- Once the invoice is paid, the business gets the remainder minus the discount rate and any additional fees
Factoring can be done on a recourse or non-recourse basis. In a recourse situation, if the client does not pay the invoice within a specified time period, the company that entered into the factoring arrangement is responsible for providing a new invoice of equal value. Most factors prefer this type of factoring to minimize the risk they assume.
In non-recourse factoring – which is the service offered by Business Factors & Finance – the factor buys the invoices outright and thus becomes responsible for collection. This type of factoring serves as credit insurance at a fraction of the cost. Non-recourse factoring typically costs more than recourse factoring in order to compensate the factor for the risk of non-payment. For more information on why non-recourse factoring may be the right choice for your business, please see our Non-recourse Factoring page.
Differences between spot and high-volume factoring
Below are some of the ways spot factoring differs from high-volume (whole ledger) factoring:
- Commitment level. Spot factoring does not require monthly minimums or a long-term contract. It is a tool that the business can use whenever needed, as long as it has creditworthy clients.
- Fee structure. Spot factoring usually has a higher discount rate, whereas the cost of factoring the whole book may be lower thanks to the economies of scale. Moreover, some factoring companies may charge penalties if the business decides to cancel a long-term agreement. This will not apply to spot factoring since it is done on an ad-hoc basis.
- Amount of paperwork. Factoring typically requires little paperwork, apart from an application, articles of organization, accounts receivable aging report and sometimes, financial statements. With single invoice factoring, financial statements and an aging report are often not needed. Our Asset-based Lending page provides more information about what is required to factor receivables.
A staffing company sent a client a $100,000 invoice and is waiting for payment. The client has 60 days to pay but the company needs working capital immediately to help fuel growth. Spot factoring allows the business to sell the invoice to a factor at a discount rate of 4% and obtain the cash within 48 hours. It now has the capital to invest in growth.
Below is a table showing the benefit of factoring:
|Factor accounts receivable||Do nothing|
|Potential gross profit||$100,000||$0|
|Less cost of factoring||$4,000||$0|
The cost of factoring varies and depends on the credit profile of the business’s client, the industry, the number of invoices factored and their dollar amount, among other things. Fees in an industry where invoices are more likely to get disputed, such as retail, could be higher than costs associated with factoring receivables from a state or government entity.
All factors will charge a discount rate – which is a fee for the factoring service. This fee ranges from 1% to 5%. Apart from the discount rate, some factors will also hold a percentage of invoice as reserve that is returned to the client once the invoice is paid. Our Small Business Factoring page explains the concept of reserve in the “How much does it cost?” section.
Here is an additional example:
- Invoice amount: $25,000
- Advance rate: 95%
- Industry: transportation
- Reserve: $1,250
- Fees: Monthly fee of 2%, capped at the amount of the reserve
- Other fees: $100 lockbox fee, capped at the amount of the reserve.
- Type of arrangement: Recourse
In this scenario, the client pays $600 ($100 for the use of lockbox plus the discount rate of 2%) for the spot factoring service until the factor collects on the invoice. The company received $23,750 in cash. If a factor is unable to collect full payment from the company’s client, the invoice will be sent back to the company for repayment. Alternatively, the company can replace the unpaid invoice with a different invoice of equal amount or higher.
When a company needs cash to fund its business or fuel growth, factoring can be an attractive solution. Spot factoring is ideal for companies that want to monetize a single invoice (or two) and not commit to long-term contracts. Benefits of spot factoring include the ability to try it out without a long-term commitment; flexibility to control which invoices to factor and when; and little paperwork. Spot factoring may have a higher discount rate than high-volume factoring due to lower economies of scale but the fees also depend on the client’s industry and credit profile, and the dollar amount and the number of invoices being factored. Business Factors provides spot, non-recourse factoring with no monthly minimums and works with you to evaluate your particular situation and structure an arrangement that’s best for your business.