How Does Invoice Factoring Work?

Factoring is a finance tool designed to allow businesses to access cash quickly so they can use it to operate and expand their businesses. One of the most attractive features of factoring is that it is actually not a business loan; it is an advance payment based upon invoices or accounts receivable owed to the business. The process of factoring is quite simple; first, the factoring company purchases an invoice from your business at a discount. Next, the factoring company will work to collect the invoice payment. Once they have collected the business payment, they will pay your business the rest of the amount owed. The fee the invoice factoring company charges will vary based on the volume of business you do with them, the length of time that the invoice takes to be paid and in some cases, the credit of the company that owes your business money.

There are two primary forms of invoice factoring: recourse and non-recourse. Companies that use recourse factoring make your company liable for any invoices that are not paid in full. Non-recourse factoring takes the risk of the invoice when they choose to purchase it from you. Factoring companies that leverage the non-recourse strategy will generally offer your business a lower purchase price to compensate for the added risk that they are taking. Depending on your current invoice payment history, you should choose the most financially viable option for your business.

Advantages of Invoice Factoring

When a business is evaluating available financing options, the process can become overwhelming. Also, if the business does not have established credit or the business owner does not want to co-sign on the debt, there are very limited financing options available. Invoice factoring is not considered debt to the business and is not a type of business loan. Factoring companies are not concerned with your business’ debts; they are only concerned with the credit worthiness of the company that they are buying the invoice for.

Another major advantage of invoice factoring is that your business can receive cash flow earlier, typically in 1 business day. While you are paying a nominal fee for the factoring services, the process speeds up, allowing you and your business to leverage those dollars to grow your business.

Step 1:
Research a variety of companies that provide the type of services that your company requires for financing, starting by deciding whether you are going to use a non-recourse or resource factoring company. Choose 3-4 that you will compare and contact each one so that you can speak with a live representative. Ask questions so that you fully understand their program and their fees.

Step 2:
In addition to the brief mention above of comparison, you will also want to read the factoring company’s policy and procedures, time lines, feedback from previous customers and you will want to review the company’s application. While fees are certainly a consideration, compare the companies to choose the best balance between cost and service provided.

Step 3:
Now that you have narrowed down the factoring companies to 1-2 finals, schedule additional phone time to speak with a representative.  Review the contract with the company representative to ensure that you understand all of the details. Probably to most important thing that gets overlooked is the fine print as it relates to fees. You will want to read through and understand time lines, what can cause a fee to increase or decrease and anything else that is specific to this factory company’s restrictions and guidelines. Also, be sure you understand how the percentage payments change by 30, 60, 90 and 120+ day payments.

Step 4:
Now that you have a full understanding of the company and the paperwork, you are ready to get started. Organize your paperwork and submit it to your chosen factoring company.

Step 5:
Once you have been approved, you will need to develop a system to send in your invoices. If you currently manage this process, add time into your calendar to manage it. If you are going to use an administrative person, make sure that you go through the details and the paperwork for them to accurately complete. Once you submit your first factoring invoice, within a few days you will receive your first payment.

By implementing these steps, you will be able to leverage factoring within your business structure. Factoring can help your business to pay down expenses quicker and also to focus on growth.

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