Invoice factoring: Is it right for my business?

Invoice factoring

If you’re a B2B business owner, you’ve probably got a stack of unpaid customer invoices lying around—that’s just the way the cookie crumbles. And although it can be frustrating waiting for these remaining balances to be paid off (especially if you’ve run into issues with working capital), there is one advantage to these unpaid invoices: a method of financing called invoice factoring. This is a great option for B2B business owners looking to increase cash flow while they wait for customer payments. 

What is invoice factoring? 

The first thing to understand about invoice factoring is that it is not a business loan. It refers to the selling of invoices at a discounted rate to a factoring company in exchange for a lump sum. The factoring company then takes ownership of the invoices, meaning they’re now the ones in charge of the payment process. You receive a percentage of the invoices and you’re off the hook in terms of collecting payment from your customers. 

How does invoice factoring work?

Let’s say you have a $10,000 invoice and your customer has agreed to pay it within 30 days. All is fine until you encounter an unexpected cash flow problem, resulting in the need for working capital sooner than expected. Sound familiar? This kind of situation happens all the time in business. 

A potential fix to this problem is to apply for a bank or small business loan, but Founders with less than stellar credit may find this route challenging. Plus, bank loans can take several months to process, meaning you won’t solve your immediate cash flow hiccough. That’s why many Founders turn to invoice factoring as a quick fix to their cash flow shortfalls. 

The basic process works like this:

  1. You sell your outstanding invoices to a factoring company in exchange for a lump sum—usually somewhere between 70 and 90 percent of the total. 
  2. The factoring company charges a factoring fee or discount rate, usually between 1 and 5 percent of the total.
  3. The factoring company advances you the cash advance in a lump sum, which is sent directly to your bank account. This money can now be used immediately. 

What types of businesses use invoice factoring?

Generally speaking, invoice factoring is used by businesses that sell products or services to other businesses. These can include (but are not limited to) the following sectors:

  • Transportation
  • Staffing
  • Manufacturing
  • Wholesale
  • Healthcare 
  • Technology
  • Service providers

What are the advantages of invoice factoring? 

There are a number of reasons why Founders would consider leveraging invoice factoring as a means of financing their business. It can be a quick fix for cash flow snags, and can be especially beneficial to businesses that simply don’t have the luxury of waiting months for a bank loan to come in. Unlike traditional financing which often comes with stipulations on how you can spend the cash, money from invoice factoring can be spent however you want. This includes purchasing inventory, repairing equipment, investing in advertising and marketing, and scaling your company. 

Advantages of invoice factoring

What are the advantages of invoice factoring? 

There are a number of reasons why Founders would consider leveraging invoice factoring as a means of financing their business. It can be a quick fix for cash flow snags, and can be especially beneficial to businesses that simply don’t have the luxury of waiting months for a bank loan to come in. Unlike traditional financing which often comes with stipulations on how you can spend the cash, money from invoice factoring can be spent however you want. This includes purchasing inventory, repairing equipment, investing in advertising and marketing, and scaling your company. 

Advantage #1: You’ll have access to immediate cash flow

A notable advantage to invoice factoring is that you’ll receive money owed to your business immediately, without having to wait for your customers to pay you the balance. Invoice factoring provides fast cash within days—even on the same day in some cases. If you have short-term financing needs or encounter a cash flow emergency, this method of funding can be especially viable. 

Advantage #2: You’re more likely to get approved 

Unlike banks, invoice factoring companies don’t require collateral, good credit, or a loan history. Rather, factoring companies are more interested in the payment history of your customers, given this is a good indicator of how much risk they’re taking on. Keep in mind that if your customers have a history of not paying on time, factoring companies may choose not to provide you with funding because of the high risk. If you’re a Founder with a low credit score or simply don’t want to offer up personal collateral, invoice factoring could be a great alternative method of business funding. 

Advantage #3: You’ll be able to outsource debt collection

“I love collecting debt from my customers”, said no one ever. Keeping track of outstanding invoices is a tedious task that can be frustrating and difficult, especially if your customers aren’t paying on time. As a result, outsourcing this responsibility can be an appealing alternative. Delegating the debt collection to a third-party means you’ll free up room to work on other parts of the business without having to worry about contacting customers for payment, ultimately creating positive and longer-lasting relationships with your clients. 

What are the disadvantages of invoice factoring? 

Before you jump on the invoice factoring train, you should carefully consider whether it’s right for your business. While this method of funding offers fast cash, it doesn’t come without its financial and operational disadvantages. 

Disadvantage #1: It can be costly 

In order for invoice factoring companies to make money, they need to charge a service fee. This is typically a small percentage of the total, which can be a significant amount for larger invoices. Founders will need to consider whether the immediate access to cash is worth the cost, particularly for a business on a limited budget. Sometimes, it might just be worth waiting for the customer to pay off the balance rather than going the invoice factoring route. 

Disadvantage #2: You’re still liable 

It’s important to remember that factoring companies aren’t collections agencies, meaning you still might be responsible for your unpaid invoices depending on your agreement. If you have a recourse invoice factoring agreement, for example, you’ll be responsible for paying your customers’ unpaid invoices. Factoring companies are unlikely to take extra time to track down late payments, meaning the task will ultimately fall on you. 

Disadvantage #3: You won’t be fully in control 

It can be hard to give up control in business, especially something as important as invoice payment. Invoice factoring involves handing over this responsibility to a third party, meaning they will have access to your financial information. Before applying for this type of funding, make sure you do your research and opt for a reputable factoring company. 

Invoice factoring vs. Invoice financing: What’s the difference? 

While invoice factoring and invoice financing are often used interchangeably, the former is actually a subset of the latter. Invoice factoring is one of a few different types of invoice financing (also known as accounts payable financing), which refers to a number of funding methods that leverage unpaid invoices to secure working capital. 

If you want to learn more about invoice financing, you can refer to the following posts:

Is invoice factoring right for my business?

Invoice financing allows businesses access to capital without waiting for payment from customers. For businesses that need fast cash, this funding option can be extremely beneficial. That being said, it’s important to consider which type of invoice financing makes most sense for your business, depending on the current financial health of your company and its future needs. If you prefer to have more control over collecting your outstanding balances, for example, you may want to consider other forms of invoice financing. But if you’d rather delegate the task of contacting customers to pay their invoices, factoring could be right for you. 

Remember that not every financing solution is right for every business. While invoice factoring can be great for some—especially those with customers that pay on time and can afford the additional fees—Founders should consider the range of options available, including merchant cash advances, business credit cards, invoice financing, and traditional bank loans.

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