What is invoice factoring and how does it work?

In short, invoice factoring is the purchase of accounts receivable, that is, unpaid invoices that are no more than 30 days old. You do the work, sell us the invoice, we advance up to 100 percent of the bill immediately and charge your customer the money.

Invoice factoring

is a way in which companies can finance cash flow by selling their invoices to a third party (a factor or a factoring company) at a discount. Invoice factoring can be provided by independent financial providers or by banks.

The process of factoring your receivables is relatively simple. It is structured through the sale of your invoices to a factoring company. The factor buys your bills and pays them right away. So, you don't have to wait 30 to 60 days for customers to pay you.

This provides your company with immediate access to funds while the factor waits for your customers to pay. Invoice factoring consists of buying outstanding invoices at a discount. You'll receive a cash advance on the purchase right after the factor verifies and purchases your receivables. Because you no longer own accounts receivable, you are not in charge of collecting them from debtors.

In addition, because factoring is not a commercial loan, you don't have to make recurring fees. According to the Wall Street Journal, “the factor advances most of the amount of the bill, generally 70 to 90%, after verifying the creditworthiness of the billed customer. Invoice factoring rates will vary depending on the sales volume and the creditworthiness of your customers. Once the factor receives and verifies the invoices, it deposits the first installment (advance) into your bank account.

Cheaper and easier than a bank loan: Invoice factoring is usually cheaper than a bank loan and easier to obtain, making it suitable for short-term financing needs. If the factoring company coldly or aggressively pursues debt, you risk that your customers will stop working with you in the future. When an invoice is sold, the third company pays the company a percentage of the total amount originally charged to the customer and generally assumes full responsibility for collecting payment from the buyer. Another consideration, which could increase the cost of factoring, is if the company opts for a no-recourse agreement, in which the factoring company assumes the risk of the customer not paying.

And when your customer pays the bill, the factor remits the balance, minus a commission, to your company. This means that the company incurs an additional “refactoring fee” and the invoice is “returned” to the company (the company will have to repay the funds previously anticipated from the invoice). Or, you can choose to manage your own bill collection efforts, even after invoice ownership has become a factor. Many businesses fail because of poor cash flow, and invoice factoring can keep yours healthy, as long as you use it wisely.

Invoice factoring companies tend to quote favorable rates and commissions at first, but the addition of additional monthly fees (or “outlays”) adds significant cost and makes this an expensive form of financing. Factoring invoices can also improve the morale of people who work in your accounts department, since chasing payments is often a stressful job. However, even when invoice factoring companies announce this option, customers are rarely able to pay an extremely high premium. Factoring companies need the application to evaluate the transaction and determine if it is right for both parties.