What Is Invoice Factoring?
Invoice Factoring Definition:
Invoice factoring, in layman’s terms, is selling your business’s invoices to quickly get the cash you need to pay for your business expenses. It’s one of the oldest forms of business finance and is a great form of alternative financing. It’s simple: you sell your business’s invoices to a factor and they do the rest.
A factor is a third party that will be able to advance you most of the money from an aging invoice and collect it from your customers for you. A factor can also provide you with guidance and financial advice throughout the process. When you work with a factor, you’ll be able to focus on running your business, not chasing down customers to pay their aging invoices.
The Finer Details
What’s important to remember when you look at the invoice factoring definition, it isn’t a loan. With a loan, you only have a finite amount of capital at your disposal, and you still have to pay back the principal amount plus interest. You also have to go through an application and approval process. Depending on how immediately you need your money, you might not have time to wait for a loan.
Factoring isn’t a line of credit, either. With credit cards, you may have a certain amount you can use and an annual APR that could cost you thousands of dollars if you have an unpaid balance over time. If you have an APR of 17% or even 22%, financing everything with a credit card isn’t a very realistic option. Even if you only need to use the credit card a few times, the interest can make that small principal enormous in the end, so you pay back far more than you took out originally.
Invoice Factoring vs. Other Financing
With factoring, you don’t need to worry about a 10-year payback period. The money the factor advances you is technically your money in the first place, and the fee a factor might charge for their services is far less than the interest you could be stuck with for a conventional bank loan.
Here’s how invoice factoring compares to other types of financing options you may be considering:
How Factoring Compares to:
With a loan from a bank, you’ll need to apply first and go through an approval process. Even if you’re approved, you still only have access to a finite amount of capital that you’ll still have to pay back at some point (a loan is a loan, after all). Even if you do get approved for the loan, you might not get approved for as much as you actually need, so it’s not quite a stopgap measure or a solution for your cash-flow problems.
Once you have the money from your loan, you can use it, but with interest compounded on top of the principal, you’re paying back much more than you took out. Let’s say you took out a $100,000 loan. Depending on the interest rate, you might end up paying back well over $200,000.
With factoring, you don’t need to worry about a 10-year payback and monthly payments like a term loan. The money the factor advances you is from your own invoices, and each advance is paid off when your Customer pays you 30 – 45 days later. Invoice factoring grows along with your Company growth and is a short-term financing solution to provide your Company the working capital it needs today.
Invoice Factoring vs Bank Loans: Which Financing Option Is Right for Your Business? →
Credit cards are typically “for emergencies only” resources, even outside of the business world. With notoriously high APRs and extra hidden fees at every turn, credit cards can be one of the worst options for business owners who need cash right away for their businesses. And you still need to be approved before you can start using a credit card in the first place!
Additionally, defaulting on a credit card or a loan can have consequences for your credit score. No matter how many points you can rack up with purchases, or how many benefits there are attached to your card, you still need to pay off that credit card. With factoring, there is a small discount fee associated with each factored invoice but once the invoice is paid by your Customer, the transaction is closed and you’re done. No APR, no monthly fees, and no recurring interest payments.
Invoice factoring and invoice financing are two terms that sound similar but are actually quite different. With factoring, you don’t need any kind of collateral and the money you receive from the advance isn’t a loan you need to pay back.
With invoice financing, the invoice itself acts as collateral and you get a cash advance on it. However, you’re still responsible for both collecting the invoice and paying back the advance. In a way, invoice financing isn’t too different from a conventional loan. If you don’t want to deal with interest or collateral, or if you’ve been unsuccessful in collecting from your customers, invoice factoring would be a better option than using invoice financing.
Recently there’s been a dramatic increase in small businesses employing Merchant Cash Advances as a source for working capital funding. Merchant Cash Advances, or MCAs for short, have become attractive due to their quick application process and fast access to capital, with the approval not being so heavily dependent on your credit score. As a result, more and more businesses, who may have previously used a credit card or their own funds for working capital, are turning to MCA lenders.
The problem with MCA loans is that many companies make two critical mistakes: 1) they don’t do the math as to the size and frequency of the cash withdrawals by the lenders, and 2) they often find themselves going to the well again, taking out a second, third, fourth, or more MCA loans — a term referred to as “stacking.” Stacking results in a cascade of daily or weekly variable withdrawals from your small business bank account, resulting in you losing complete control over the Cash Flow you were trying to fix when you took out the advance in the first place. Factoring doesn’t involve withdrawing money from your small business bank account, but rather, depositing money quickly into your account from the fruits of your labor as Advances made against your invoices for products or services your business has provided Customers. With factoring, there are no tricks, no unexpected withdrawals — just plain predictability and consistent working capital.
Factoring: the Easiest Way to Get Your Funds
Invoice factoring, compared to other conventional forms of business financing, is a much easier method of securing funds for your company. You don’t need to worry about interest rates, daily withdrawals, or having to pay off all the money borrowed plus interest at the end of the term loan. And as an additional benefit, your Factor handles the Collections, freeing you up to spend your time successfully running and growing your B2B business.
Frequently Asked Questions
Have questions about invoice factoring services for your B2B business? We have answers.If you’re unsure if factoring is right for you, read over our FAQs to get more information.
Invoice factoring is one of the oldest types of business finance and is one of the best alternative financing options available to small business owners. Factoring involves the purchase of your accounts receivable for cash, at a slight discount to your invoices face value, in order to quickly provide working capital for your growing business.
By purchasing your accounts receivables, a Factor advances you typically 80% – 90% of your invoice value and then collects it from your customers for you. A reliable factoring firm will also provide you with guidance and financial advice throughout the process. By working with a trusted Factor, you’ll be able to focus more time on running and growing your business, not chasing down customers to pay their aging invoices.
Absolutely! At ei Funding, we love new companies. Every big company today was at one time a new company. Unlike banks, factors generally don’t call for very much history of a company since we rely heavily on the creditworthiness of your customers.
This allows you to get going almost immediately and focus on what you do best — grow your business. With years of factoring experience working with small companies, we at ei Funding are in a position to help you get the results you deserve.
SmartPricer, a sibling company of ei Funding, has created advanced software to make the process of getting a home mortgage easier and more efficient. We use our software to analyze all the available mortgage options in the market and then recommend the best ones that match your unique requirements. This helps you make quicker decisions, save money, and receive top-notch customer service.
People often wonder: “Is factoring a loan?” The answer is no, and here’s the difference between the two:
With traditional bank financing, rates tend to be slightly lower, however, the approval criteria along with other restrictions, have grown recently, making it much more difficult to obtain, especially for small businesses and start-ups. When banks provide a line of credit, this is a debt, which will show up on your company balance sheet and be tied to some form of collateral of yours or the company’s, creating further restrictions.
Factoring, on the other hand, is not debt, but rather an advance against your invoice for products or services. Each advance is tied to a specific transaction, and as a result, is used only when you want to use it. It grows as your company grows, and is there for as long as you need it, since the money provided you are advances made against your own, earned invoices.
Learn more about how factoring compares to other financing online now.
Yes. If you, or your company, have a blemish on your credit record, we understand that. What makes invoice factoring special is that the focus of our credit analysis is not based entirely on you, but also on your company, and the quality of your clients, since ultimately it is they who will be paying your invoices. So although bad credit is not something we encourage, it is not a show stopper for obtaining factoring services for your growing business.
Contracts spell out the rules of the game for both sides, and at ei Funding, we do our best to make sure ours are clear so that everyone knows how things work. As far as contracts go, you can cancel your factoring agreement at any time, and the only thing we require is that it be done in writing 30 days before your intended stop date.
We are committed to a simple and transparent rate structure designed to help you keep more of your hard-earned money. And finally, if for whatever reason we don’t meet your service expectations, then we don’t want to stand in your way to find a service provider who does.
This is something we are asked all the time. There’s a misconception that factoring is a costly option compared to bank financing, when actually, a business ends up paying only a few pennies for each dollar factored.
As an example, a $1,000 invoice will typically cost anywhere between $25 – 40 in factoring fees, so when we say it only costs cents on the dollar, we really mean it.
No. Invoice factoring is not considered debt. It involves the purchase by the Factor and the sale by the Client, of invoices for goods and services.
Because of this fact, small businesses may use invoice factoring even if they already have a line of credit with a commercial bank.
There are many advantages of choosing factoring as an alternative for financing your business. Here are some of the best reasons to use invoice factoring for your business:
- Immediate cash advances, typically same-day, for your Invoices
- It’s not debt, so no monthly term payments
- It’s flexible — you use it only on the Customers you choose
- It inexpensive, costing your business only pennies on the dollar
- You receive 80 – 90% of your invoice amount up front, in cash
- It grows with your business
- It provides necessary cash flow to manage through potential slowdowns or Seasonality which are a normal part of your business
When applying online, we recommend you have all of your most important documents on hand. This includes your driver’s license, Social Security number, articles of incorporation of your business (LLC, Corporation, or other), and your business tax I.D.
You’ll also need financial documents that account for at least two years:
- Balance sheets
- Profit and loss (P&L) statements
- Corporate tax returns
- Three months of bank statements
We like to do things right, so we typically take a week to 10 days to get you set up, once we’ve received all the necessary information from you, although if needed, we take as little as 24 – 48 hours.
From our experience, we’ve learned that what’s most important to you in the long run, is not the fast setup, but the fast funding — of the correct amounts, when and how you need it. We do our best to get you set up quickly, but since we also depend on you providing us the requested information, we’ll work to get it done in as little time as possible.
You can easily apply online any time. And once you’re approved and set up, in cases where you already have invoices to approved customers, it’s likely we can get you funded on those right away.
Factoring is widespread in many industries including Staffing, Construction, and Transportation, and many Customers including Shippers and Brokers actually prefer dealing with Factors for accounts receivables management.
To these Customers, it shows you take your invoicing seriously and see the value of putting accounts receivables management with us, and therefore allowing you to focus on what you do best — running and growing your business.
As you know, running a small business takes a lot of work. Although our focus is Factoring, we also offer Purchase Order Financing and Debt Consolidation as part of a factoring facility set-up. We are focused on finding the best solution that works for your growing small business, because at ei Funding, your success is our success.
How Invoice Factoring Works
With factoring, you don’t need to worry about a 10-year payback period. The money the factor advances you is technically your money in the first place, and the fee a factor might charge for their services is far less than the interest you could be stuck with for a conventional bank loan.
Here’s how invoice factoring compares to other types of financing options you may be considering:
The Process for Factoring an Invoice
Deliver goods or services as you normally do for your Customers.
Provide your product or service as you normally do. This part is easy because it doesn’t require you to change anything you’re currently doing within your organization’s processes.
Send invoices to your Customers.
Send an invoice to your Customers. Once you’ve provided your product or service, you send an invoice with the amount owed to your business.
Sell your invoices to a factoring company and get paid an advance of 80 – 90% of the invoices.
Sell your invoices to a factor and get paid. You select a factoring company to work with and then sell them your raised invoices. Once the invoices have been verified as valid, your factoring company will immediately advance you the majority of the amount being invoiced (usually between 80 and 90%) minus a small fee so your cash flow is freed up. This advance can help B2B businesses through beginning-of-the-year droughts in accounts receivable or help growing companies make immediate changes to their processes so they can continue on their upward trajectory.
Your factor collects payment directly from your Customers.
Your factor collects payment from your Customers. It can be difficult — especially if your customers are friends or acquaintances — to constantly follow up and chase after customers to get paid. But a factor can give you cash upfront so you get the funding you need right away. And because you’ve sold your invoices to a factor, it’s now their responsibility to collect on payments directly.
Once your factor has been paid in full, they’ll pay you the remaining invoice balance minus the fee for factoring.
Once the factor has been paid in full, they’ll pay you the remaining balance. Your factoring company will secure payments from your Customers and provide you with the remaining invoice amount owed.
Why Choose Small Business Invoice Factoring?
Factoring is one of the best-proven methods of alternative financing for businesses across a variety of industries and locations throughout the world.
It’s a way for any growing company to get paid quickly. It’s a chance to boost your cash flow while waiting on Customers to pay their outstanding invoices. It’s a cash boost to support quickly growing companies. Each business situation is different, but at the end of the day, this kind of alternative financing is extremely versatile and makes sure you’re not leaving money on the table when you need it most.
Take our factoring quiz to learn if invoice factoring is right for your business!
Who Can Use Factoring?
Any B2B business that invoices their customers can use factoring to get the funds they need. Businesses in industries from manufacturing to professional services can use invoice factoring to their advantage. So long as you produce an invoice for goods you deliver or services you render, you can use invoice factoring.
While any company can use invoice factoring services, there are a few types of businesses that can benefit the most from using it. These include:
Cable constructions services (for telecommunications)
Staffing services (for hotels, restaurants and rental car agencies)
Retail distribution companies
Manufacturing
Marketing and PR agencies
Craft distilleries and breweries
Wholesale distribution of PPE & COVID-19 self-test kits
Highway repair and maintenance
Some of the Biggest (and Best) Reasons to Use Invoice Factoring Services
How do you know if you really need invoice factoring? If your outstanding A/Rs are holding you back from purchasing the supplies you need, making payroll or even hiring new people, small business invoice factoring is an option for you.
Here are some of the best reasons to use invoice factoring for your business:
Just like children, developing businesses have growing pains, too. And while that’s a great problem to have, you still need a solution. If you want to sustain growth for your company, you’ll need fast and immediate access to cash. If you don’t have the liquidity to hire more staff, you could find yourself swamped with work and stretched too thin to complete it all.
Factoring is a quick way to keep pace with your growing needs, whether it’s for recruiting, new software or something else to keep your business growing.
If you need to keep the lights on, pay for new supplies to ship an order or make payroll today, liquidity is everything. Factoring can often be a lifeline for businesses that have outstanding receivables piling up. In moments like those, you can’t afford to wait on a client to pay the invoice or go through the waiting period that applying for a business loan entails.
Imagine having access to the funds you need to make all of those possibilities happen! Small business invoice factoring can provide just that.
When you take out a loan, you have the bonus of putting it on your balance sheet. But in some cases, you may not have the assets necessary to secure a loan in the first place. That can include sufficient cash, A/R, inventory, machinery or equipment to collateralize debt.
Instead of trying to come up with enough assets to secure a loan, you can just sell invoices to get the money that you’re already owed for a modest fee. And because factoring isn’t a loan, you don’t have to worry about interest rates either.
We all know it: things can happen that ruin your credit. If you have a low credit score, though, or if you just don’t have enough credit at all, a bank may reject you for a loan. Bankruptcies or legal disputes caused by debt can give the bank a quick reason to discount your application because it represents a risk to them as the lender.
You wouldn’t want to give someone $20 if you knew they’d never give it back, right? A bank also doesn’t want to give out money to anyone that might not be able to pay the principal and interest back in full.
We’ve said it before, but the application process for a bank loan can place incredibly high pressure on a small business owner just trying to find their footing. There are dozens of reasons a bank can turn you down for a loan, like risk or already having too much debt, which can make things complicated.
Having a poor credit score alone can limit your ability to take out a loan, but you can get trapped in a vicious cycle if you run to a credit card instead.
Your book of business might be made up of a healthy mix of “high roller” customers and smaller accounts, or you might rely on a few major accounts. While it’s generally a good idea to have a balance between these big and small accounts, new and returning customers and your revenue mix at large, we all know that doesn’t always happen.
What happens when a few big accounts that are slow to pay? You may end up in a feast-and-famine cycle for your cash flow. Factoring can help alleviate some of that strain when you’re waiting for your customers to pay and get you out of that vicious cycle.
What Other Value Can a Factor Provide You?
When you work with a trusted and professional factor, you can rest easy knowing you’re working with a financial advisor and business partner that has your company’s best interest in mind. Often, a factor can also help guide you through tough or unexpected situations, especially when it’s your funding that’s on the line.
In the case of the unexpected, being prepared with a trusted factor can make a huge difference for your B2B business. Beyond invoice factoring, a factor can also consolidate your debt and keep fulfilling your customers’ orders to keep growing your company. At ei Funding, for example, we can also help with debt consolidation and P.O. financing.
Debt Consolidation
Debt consolidation is when you, the business owner, roll short-term funding loans like Merchant Cash Advances (MCA) into one loan. This lowers both the amount of interest you pay out as well as the payback period for your loans.
Like the name implies, debt consolidation doesn’t magically make the debt go away, but it does make it easier to manage. Short-term funding options like MCAs can add up quickly. Having one, two or even three MCAs to pay back can really put you under financial stress if you try to pay off everything at once.
Debt consolidation, like factoring, helps to put you back in control of your cash flow. “Stacking” too many MCAs can result in variable amounts coming out of your accounts. But with debt consolidation, you have one loan and a known amount being withdrawn from your business account each month.
P.O. Financing
P.O. financing, or “purchase order financing,” is a form of asset-based financing that enables you to fill orders for your customers. When you use P.O. financing, you don’t sell equity or take on debt. Rather, it helps you finance manufacturing transportation suppliers so you can fill an order with the invoice securing the financing itself.
P.O. financing is a little more restrictive than simple invoice factoring. P.O. financing can only be used to finance purchases that help you fulfill your customer’s order. However, it still isn’t a loan, so you don’t have to worry about a lengthy application process.
As far as business finance options go, P.O. financing can be a great choice for wholesalers, manufacturers and other similar businesses. It can be especially useful if your orders come in a seasonal cycle, with a spike that outstrips your liquidity or available capital to fill the order.
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