This article is written by our friends at FundThrough.
Invoice factoring is a form of financing where a business owner sells invoices to a factoring company for fast access to funds. The business owner receives cash for the invoice amount, usually less any fees, ahead of the payment terms. The business owner's customer, who is responsible for paying the invoice, instead pays the invoice amount to the factoring company according to the original payment terms.
Invoice factoring also goes by the terms accounts receivable factoring or receivable financing. (It's important to note that this is different from invoice financing, where a factoring company still gives a business owner cash for their invoice, but the business owner pays back the invoice amount themselves, plus a fee. Find out how to choose between invoice factoring vs invoice financing.
This simple definition doesn't tell the whole story about factoring. To understand factoring and why many businesses use it, it's helpful to understand what it is not. There are a lot of misconceptions about factoring that have given it a bad reputation.
It's not a loan; business owners don't have to worry about paying the money back because their customer pays the factoring company. Most importantly, choosing to factor invoices doesn't mean a business is struggling or can't reliably serve its customers. Add to this perception that many traditional factoring companies charge hidden fees, don't fund the full invoice amount, and take weeks to pay, and you can see why some people have a bad impression of factoring.
Thankfully, the truth couldn't be more different: Invoice factoring makes businesses more successful when they need to maintain their cash flow in the face of long invoice payment terms. (In fact, it often helps business owners stress less about their cash flow situation.) Let's get more specific.
The reason there's a demand for invoice factoring is because of cash flow issues caused by long business to business (B2B) payment terms. In many industries, it's not uncommon for standard payment terms to be anywhere from 30 to 120 days. Instead of business owners being paid right after they've delivered goods and/or services, they have to wait to receive customer payments.
This is a particularly difficult problem for small business owners who have large customers. They are excited to close a household-name customer for a large contract, but when they read the payment terms, they see that they won't receive the money for months. This impacts their ability to maintain positive cash flow, not only making it difficult to run their business, but causing them anxiety. These small business owners need that money sooner rather than later to pay expenses, which can include:
Those last two points are more common than you might think. With improved cash flow, many small businesses find themselves able to bid on projects that will require them to buy lots of materials or labor. Companies that had to turn down business due to a lack of cash can take on the extra volume. If this sounds like a stretch, just take a look at our customer stories. Run Veggie and Global Pipeline are two companies who are particularly direct examples of growing with invoice funding.
To understand how they were able to get paid quickly, it's helpful to understand some basic information about the process.
Every factoring company, business, and their customers are different, so these steps are generalized accordingly. This is more or less what you can expect when you factor an invoice.
Small, growing businesses see multiple benefits of factoring, especially if they don't want to be tied up with a bank loan. Here are a few benefits they typically see:
Like any financing method, factoring isn't perfect. Here are the main perceived disadvantages of factoring invoices:
Get more info on invoice factoring advantages and disadvantages.
Invoice factoring is useful boost to your business finances for a variety of reasons:
Not exactly – but it can help you get more money in the long-term. If you have the cash to take on more business than if you'd waited for a customer to pay according to a 30, 60, or 90 day invoice payment term, you'll grow your business and ultimately make more money. Our customer stories have many examples of how this works for all kinds of businesses.
Your company should use an invoice factoring solution if:
It depends on the requirements of the factoring company. Many require you to have a certain length of time in business, minimum invoice volumes, or only work with particular industries. It's important to look into these requirements to help you decide whether to use invoice factoring services or if you're evaluating an invoice factoring agreement from a factoring firm.
Be sure to also ask whether they require a service fee and about their advance rate (or the amount that's typically paid to you up front. Some factoring companies for example will advance 80 percent of the invoice when they fund you and keep the remaining 20 percent until your customer pays. This is called the factoring reserve.) Some also require that you fund up to a certain minimum instead of letting you fund just a single invoice.
Want to see if invoice factoring can work for your business? Get started with FundThrough and receive $25,000 in free first-time funding.
Also called receivable factoring, invoice factoring is a financial tool designed to provide a quick cash advance. A business owner sells invoices to a factoring company. The business owner receives cash for the invoice amount, usually less fees, ahead of the payment terms. The business owner's customer, who is responsible for paying the invoice, instead pays the invoice amount to the factoring company according to the original payment terms.
It means that you get cash for unpaid invoices quickly, rather than having to wait on your customer to pay according to 30, 60, or 90 day payment terms that they dictate. In other words, you can turn unpaid invoices into cash.
In addition to factoring, another related funding solution is invoice financing. This is when a factoring company still gives a business owner cash for their invoice, but the business owner pays back the invoice amount themselves, plus a fee.
Wondering what is invoice discounting and factoring? Invoice discounting is essentially a loan secured against your outstanding invoice, whereas invoice factoring involves an invoice factoring company purchasing the unpaid invoices outright.
Here are a few invoice factoring examples from real clients:
See more on our customer stories page.
If you started this article unsure about what invoice factoring is, you now have a comprehensive explanation. Beyond the dry definition, it's important to know what it isn't, why business owners use factoring, and how it works at a high level. A solid understanding of the whole picture and process makes you fully informed about this financial tool and how it can make a difference not only for a business itself, but in the life of the business owner. If you have further questions about factoring, our Complete Invoice Factoring Guide has the answers.
We've found that when a business owner has steady cash flow, they're freed from a huge hurdle keeping them from growth, and they no longer worry about having enough cash to keep their business running – even if they have enough money in accounts receivable. Having peace of mind about cash flow while being able to grow their business is why so many successful business owners take advantage of invoice factoring.
If you're ready to factor an invoice, or just want to have the option in your back pocket, sign up for a free FundThrough account today.
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