Invoice Factoring: The Ultimate Guide for Small Businesses

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What Is Invoice Factoring?

Invoice factoring is different from many other types of small business loans available on the market. In short, invoice factoring is a form of accounts receivable financing in which you sell your outstanding invoice from customers to a factoring company—sometimes called a factor—at a discount.

In exchange for your invoices, you receive funds from the factoring company almost immediately, instead of having to wait for your customers to pay you.

Invoice factoring is a particularly noteworthy financing solution for B2B or service-based businesses who have funds tied up in outstanding invoices. Invoice factoring can be used to fix cash flow problems, especially for seasonal businesses.

In this guide, therefore, we’ll break down everything you need to know about invoice factoring so that you can decide if it’s the right financing solution for your business.

How Does Invoice Factoring Work?

Now that we have a basic definition of what invoice factoring is, let’s take a more detailed look at how this type of business financing actually works.

Once again, as we mentioned above, invoice factoring is very different from many other types of financing. Unlike a traditional term loan—where you receive a lump sum of capital that you pay back, with interest, over a set period of time—with invoice factoring, you sell your outstanding invoices to a factoring company in exchange for an advance of capital.

Generally, factoring companies will be able to advance you up to 90% of the value of your invoices—and once they’ve verified the invoices—transfer you the funds in just a matter of days. Then, the invoice factoring company will take over the responsibility for collecting on the outstanding invoices. As we’ll discuss below, this is one of the inherent differences between invoice factoring and invoice financing.

Once your customers have paid the invoices, the factoring company will transfer you the remaining percentage of funds, minus their fees. Typically, invoice factoring companies charge their fees as factor rates. In essence, this means you’ll be charged a small percentage fee (usually 1% to 2%) on the total value of the invoice for each week it takes your customer to pay it. 

Additionally, in some cases, factoring companies will also charge a processing fee (usually around 3%) at the point of sale.

Invoice Factoring Example

With all of this information in mind, let’s break down an invoice factoring example to get a more comprehensive understanding of this type of financing.

Let’s say that you have an outstanding invoice of $200,000. 

You apply for invoice factoring and the factoring company agrees to advance you 80% of the invoice value upfront. You receive $160,000 and the remaining $40,000 is held by the factoring company.

The factoring company charges a 1% factor fee on the total value of the invoice for each week it takes your customer to pay it. In this case, it takes your customer three weeks to pay the invoice. Therefore, the invoice factoring company will collect 3% in fees from the total invoice amount—$6,000.

This being said, of the remaining $40,000 that the invoice factoring company held, you’ll only receive $34,000 back.

All in all, then, you’ve received $194,000 of a $200,000 invoice.

On the other hand, however, you might find that the factoring company charges you an additional 3% processing fee. In this case, you’d end up paying a total of 6% in factoring fees—meaning of the $200,000 invoice, you’d only be receiving $188,000 at the end of the day—and pay a total of $12,000 in fees.

Invoice Factoring Rates

So, what do the rates typically look like for invoice factoring?

As we mentioned, as opposed to the interest you’d pay with a traditional term loan, you’ll pay factor fees with this type of business financing. Typically, these fees will range from 1% to 3%—but may reach as high as 5% of the total amount of the invoice.

Along these lines, it’s also important to note that although many invoice factoring companies simply charge a flat factor fee for each week the invoice goes unpaid—others charge this rate on a tiered-structure. In this case, the longer the invoice goes unpaid, the higher fees you’re charged. As an example, you may pay a 1% fee for the first week the invoice goes unpaid, but after the second week, this fee will grow to 1.5%.

Overall, however, the factoring company will consider your business’s industry, invoice volume, customer payment history, among other qualifications to determine the specific factor rate they charge you.

This being said, it’s important to keep in mind other types of fees that you may be charged, such as:

    Processing fee: As we mentioned, an invoice factoring company might charge a processing fee—similar to an origination fee—simply for the costs involved with processing your agreement and funding. Typically, these fees are around 3% of the total invoice amount.

    Collection fee: Some companies will charge you an additional fee for collecting the invoice payments from your customers.

    Monthly minimum fees: Although some invoice factoring companies will allow you to work with them for a one-time financing need, others will require that you sign an ongoing agreement. In this case, you may need to commit to factoring a certain amount of invoices every month. If you’re unable to meet this minimum, you may face an additional fee.

    Termination fees: Similar to monthly minimum fees, these are fees you might be charged for canceling a long-term contract with your factoring company.

    Maintenance fees: Maintenance fees are simply those that the factoring company charges you to have an account open with them—you also often see these types of fees with business lines of credit.

Finally, when it comes to invoice factoring rates, you’ll also want to understand the difference between recourse and non-recourse invoice factoring.

In short, recourse factoring refers to invoice factoring in which you, the business owner, assume the risk if your customer fails to pay back the invoice. This type of factoring is less risky for the factoring company, meaning you’ll often see lower factor rates.

This being said, however, in this case, you’ll be responsible for the costs of this unpaid invoice and need to purchase the invoice back from the factoring company—in other words, pay the company for the total value of the invoice.

Non-recourse factoring, on the other hand, means the invoice factoring company assumes the risk if your customer fails to pay. Although this lessens the burden on your business, factoring companies will often charge higher fees and will be more selective with the businesses they work with for this type of invoice factoring.

Use our invoice factoring calculator to estimate the total cost of factoring for your business.

Invoice Factoring Terms

Once again, unlike more traditional types of business loans, the terms for invoice factoring are not a specified number of weeks, months, or years. Instead, there aren’t really “set” terms—the fees you pay and the time it takes you to receive the remaining percentage of your invoice depends on when your customer pays the invoice.

This being said, however, there may be additional terms to keep in mind when it comes to your invoice factoring agreement. As we mentioned with regard to fees, the invoice factoring company may require that you commit to a certain amount of invoices on a monthly basis with them, they may require that you sign a long-term contract, and they’ll certainly designate which party is responsible for unpaid invoices.

If an invoice factoring company allows you to factor a single invoice with them and doesn’t require a long-term contract, this is often referred to as spot factoring. On the other hand, if you’re required to submit all customer invoices to the company on a regular basis for factoring, this is referred to as whole ledger or sales ledger factoring. Similar to recourse vs. nonrecourse factoring, you’re more likely to see higher fees with spot factoring—as this offers more flexibility for your business, as opposed to the factoring company.

All in all, therefore, it’s extremely important to understand the terms of any invoice factoring agreement that you receive (not doing so is a common invoice factoring mistake businesses make)—so you know exactly how you’re being charged, what your responsibilities are, and how you’ll be working with the factoring company.

Invoice Factoring vs. Invoice Financing

Finally, the last important thing to understand about how invoice factoring works is how this type of business financing differs from invoice financing.

Invoice financing and invoice factoring are often used interchangeably, however, there are a number of distinctions between the two. 

First and foremost, whereas with invoice factoring, the factoring company purchases your invoices at a discount—with invoice financing, a lender allows you to borrow money from them against your outstanding invoices. In this way, invoice financing is much more akin to a traditional loan or line of credit—once your customer pays the invoices, you’ll pay the lender back the amount loaned, plus fees. This being said, in some cases, the lender will deduct the fees before transferring the remaining amount to your account, and in other cases, you’ll need to pay the lender fees yourself after receiving the funds.

In addition, another distinction between invoice factoring vs. invoice financing is who is responsible for collecting the payment from your customers. Typically, with invoice factoring, since the factoring company has assumed ownership of your invoices, they’re responsible for collecting the payments from your customers. 

For some businesses, this is a huge benefit of invoice factoring—as you don’t have to worry about the responsibility and process of tracking down payments. On the other hand, however, other businesses would prefer not to interrupt their relationship with their customers by having a third-party (the factoring company) collect payments.

Nevertheless, the important difference here is that with invoice financing, you remain responsible for your invoices and collecting payments from your customers.

With this in mind, because of these distinctions, invoice factoring is typically more expensive than invoice financing, as the factoring company is taking on the responsibility (and risk) of collecting on your invoice payments. 

Once again, however, invoice financing and invoice factoring are often used equivocally—even by lenders and factoring companies—despite the fact that there are important differences. 

Therefore, if you’re considering either of these types of financing for your business, first, you’ll want to determine which option you prefer. Then, you’ll want to clarify the offerings of any small business lender or factoring company to ensure you understand how your financing would actually work and likewise, what your responsibilities would be.

Pros and Cons of Invoice Factoring

At this point, you should have a solid understanding of what invoice factoring is and how it works—but is it right for your business?

Of course, invoice factoring will only be a financing option for your business if you invoice customers and could benefit from an advance of capital while you wait for your invoices to be paid. With this in mind, let’s take a look at some of the other advantages and drawbacks of invoice factoring:

Top Invoice Factoring Companies for Small Businesses

As you can see, invoice factoring is an ideal business funding solution for B2B or service-based companies who have capital tied up in outstanding invoices—particularly those that can’t qualify for other types of financing, like startups or businesses with poor credit.

So, if you think invoice factoring may be an option for your business, you’re likely wondering where to apply. Although there are a number of different invoice factoring companies (and invoice financing companies, for that matter), here are a few of the top options:

BlueVine

BlueVine offers fast and easy invoice factoring that you can apply for completely online. Plus, unlike other factoring companies, BlueVine doesn’t inform your customers that you’re working with a factoring company—instead, your customers simply pay their invoices to your BlueVine account, as opposed to your business bank account—allow you to maintain your relationship with those customers.

Amounts: $20,000 to $5 million; up to 90% of the value of the invoices

Fees: 0.25% to 1.7% per week the invoice goes unpaid

Funding time: As fast as 24 hours; average of two to seven days

Qualifications: Minimum of three months in business, a minimum personal credit score of 530, and at least $120,000 in annual revenue

Read our full review of BlueVine.

altLINE

Like BlueVine, altLINE offers fast invoice factoring through an online-based process. Overall, altLINE works primarily with staffing and consulting firms, but they also fund businesses in the manufacturing and distribution industries, as well as government contractors. This being said, unlike BlueVine, altLINE requires that you are able to factor at least $15,000 per month with them.

Amounts: Up to $4 million per month; 90% of invoice amount

Fees: 0.5% to 3% for the first 30 days the invoice is outstanding—after 30 days, fees increase incrementally every 15 days and max out at 5%

Funding time: As fast as 48 hours

Qualifications: Minimum credit score of 500; no annual revenue or time in business requirements

Read our full review of altLINE.

Triumph Business Capital

Backed by a publicly traded bank, Triumph Business Capital stands out as an invoice factoring company due to their industry expertise. This being said, although their invoice factoring product will be the most accessible for small businesses, they also offer a variety of other financing products—allowing you to upgrade your solution as your business grows.

Amounts: Up to $5 million per month

Fees: $300 origination fee; factor fees depend on your unique agreement—Triumph considers whether you opt for recourse or non-recourse factoring, the credit of your customers, etc. to determine your fees

Funding time: Five to seven days

Qualifications: Minimum of one year in business, a minimum personal credit score of 500, and at least $100,000 in annual revenue

Read our full review of Triumph Business Capital.

The Bottom Line

At the end of the day, invoice factoring is a fast and easy way for businesses to access capital when they have funds tied up in outstanding invoices.

As a form of accounts receivable financing, invoice factoring is fairly easy to qualify for—making it a particularly worthwhile option for startups or businesses with poor credit. 

This being said, however, invoice factoring won’t always be the right solution for every business. As we’ve discussed, invoice factoring can be expensive, as well as pose certain risks.

Therefore, if you’re looking for invoice factoring, you’ll want to remember to thoroughly review any quote, contract, or agreement you’re offered. You’ll also want to compare offers from multiple companies to ensure you’re getting the best factoring receivables deal for your business.

Additionally, if you do decide to work with a factoring company, you might avoid a common mistake businesses often make with regard to invoice factoring by proactively reaching out to your customers and taking steps to maintain those relationships.

Of course, before settling on invoice factoring, you’ll also want to consider the other types of business financing out there—including invoice financing, and more—to see if there is another solution that’s a better fit for your business’s needs.

Randa Kriss

Randa Kriss is a senior staff writer at Fundera.

At Fundera, Randa specializes in reviewing small business products, software, and services. Randa has written hundreds of reviews across a wide swath of business topics including ecommerce, merchant services, accounting, credit cards, bank accounts, loan products, and payroll and human resources solutions. 

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