Menu
Key Summary Points: Is Invoice Factoring a Good idea?
Invoice factoring is often a good idea for B2B businesses with cash flow challenges because it eliminates the wait of net terms.
- Invoice Factoring Overview: Invoice factoring allows businesses to sell unpaid invoices to a third-party company for immediate cash, improving cash flow without adding debt.
- Benefits of Factoring: It provides quick working capital, easier qualification than loans, no additional debt, outsourced collections, and flexible terms.
- Potential Drawbacks: Factoring fees are higher than bank financing, some businesses worry about customer perception, and recourse factoring carries repayment risk if customers default.
- Ideal Use Cases: Factoring benefits B2B businesses facing cash flow gaps, seasonal fluctuations, payroll needs, or growth.
- Choosing a Factoring Company: Businesses should evaluate flexibility, costs, advance rates, contract terms, and customer service before selecting a factoring provider.
Small businesses needing financing will look at invoice factoring as an alternative financing option, but wonder if it’s a good idea compared to options like merchant cash advances, asset-based lending, business credit cards, or trying to work with a small business bank. We’ll make the case that factoring is quicker, easier, and more flexible and go over considerations like costs and customer perceptions.
We’ll provide our expertise on whether this type of financing is a good idea for those looking for a quick answer, more information to help you decide for yourself, and a primer on invoice factoring.
What Is Invoice Factoring?
Invoice factoring, also known as accounts receivable factoring or debt factoring, is when a business sells its unpaid invoices to a third-party factoring company in exchange for improved cash flow. This process allows businesses to improve cash flow without taking on additional debt.
Is Invoice Factoring a Good Idea?
Yes, invoice factoring can be a great solution for businesses facing cash flow challenges. It provides immediate access to cash tied up in unpaid invoices, allowing you to cover operational costs, payroll, or growth initiatives without waiting for customers to pay.
That’s the short answer–but consider this nuance:
Invoice factoring is worth it if you’re grappling with cash flow issues because unlike other financing, it’s designed to solve that specific problem. For small and medium-sized businesses, extended net terms cause a lack of cash flow. Factoring fixes this by paying your invoices immediately, allowing you to skip waiting on net terms to get capital you’ve already earned–rather than adding more debt to your balance sheet. With that said, how valuable it is hinges on your specific needs and the factoring partner you choose.
How Invoice Factoring Works
- You apply to sell outstanding invoices to a factoring company.
- They underwrite your business and your customer to ensure they are creditworthy.
- The factoring company sends your customer a Notice of Assignment, a document requiring your customer to acknowledge that they will redirect future payments to the factoring company.
- The factoring company verifies that your customer accepts your invoices
- The factoring company advances a percentage of the invoice (typically 80%-100%).
- The factoring company collects customer payments on net terms.
- Once the invoice is paid, you receive the remaining balance minus factoring fees.
A Real Life Example of Invoice Factoring Costs
Let’s say you have a $100,000 invoice:
- You receive an 85% advance = $85,000 payment to you upfront.
- The factoring fee is 2.75% per 30 day payment terms = $2,750.
- When the customer pays, you receive the remaining balance of $15,000 minus fees, which equals $12,250
- Total received = $97,250 (effective cost = $2,750).
It’s important to note that FundThrough can advance 100% of your invoice less fees, giving you more cash upfront with a simpler process.
Ready to get paid early?
The Use Cases for Invoice Factoring
According to QuickBooks, 61% of small businesses struggle with cash flow consistently. Per JP Morgan, the average small business holds 27 days’ worth of cash reserves. It would be impossible to invest and leverage growth opportunities with such limited cash flow. Even funding day-to-day business operations would be challenging.
If you’re a B2B business and any of the scenarios below resonate with your current situation, you might want to consider the benefits of invoice factoring as a funding option:
- Business Growth or Upcoming Projects: Expansion and new projects demand significant capital. Factoring converts outstanding invoices into instant cash, fueling your growth without the wait to get paid or get raise a line of credit limit. Hire more employees or buy raw materials in bulk.
- Payroll Needs: Meeting payroll is non-negotiable. Factoring ensures you have the necessary funds on hand, maintaining your team’s trust and morale.
- Seasonal Fluctuations: For seasonal businesses, cash flow can be unpredictable. Factoring stabilizes your finances by providing cash when you need it, ensuring smooth operations year-round.
- Unexpected Expenses: Emergencies don’t wait for convenient timing. Factoring offers quick cash to tackle unforeseen costs, keeping your business resilient
- Boosting Cash Reserves: Enhancing your balance sheet with more cash make your financials more attractive to investors.
- Cash Flow Stress: The anxiety of managing cash flow distracts from strategic goals. Factoring alleviates this stress by ensuring steady, predictable cash inflow.
All of the above are situations in which funding is needed to grow or remain in business, but cash flow challenges stand in the way. See invoice factoring examples for how factoring helps in these situations.
What are the advantages of factoring?
There are many obvious benefits of factoring, as well as a few that are lesser-known value-add:
- Quick Working Capital: Get immediate access to funds you’ve already earned.
- Easier Qualification: Approval is based on customer credit history, not your business credit.
- No Additional Debt: Factoring is not a loan, so it won’t impact your debt ratio.
- Outsourced Collections: The factoring company handles invoice collection with a professional, experienced team.
- Flexible Terms: Some factoring companies (FundThrough included!) allow spot factoring, where you choose which invoices to factor.
- Outsourced A/R management: For example, FundThrough’s team processes an average of $230,000 in payments per client per month, reducing administrative cost.
- Contract insights: Our team has pointed out clauses that need our client’s attention in the course of reviewing customer contracts.
- More time for strategic priorities. Because you aren’t having to manage cash flow as tightly
- Option to pass on the fees. Some FundThrough clients have negotiated to have their customers pay factoring fees in special situations.
- Customer credit checks. Get feedback on your customer’s credit so you can be more informed.
What are the disadvantages of factoring?
On the flip side, it’s also important to consider the disadvantages of receivable financing in the context of your business’ situation:
- Customer Interaction: Some businesses worry about factoring companies dealing directly with their customers.
- Industry-Specific Suitability: Factoring is ideal for B2B companies but not for B2C businesses.
- Recourse vs. Non-Recourse Risk: In recourse factoring, you’re responsible if the customer doesn’t pay; in non-recourse factoring, the factoring company assumes the risk (but at a higher cost).
- Can appear expensive. Invoice factoring rates vary between 1% and 6% per 30 days, and some companies add additional costs, like service fees. (FundThrough charges one flat fee.) Bear in mind the total value you’re receiving, such as A/R management, collections, and insights,
- Stigma attached to small business invoice factoring. Some business leaders worry it signals financial trouble, but many use it to fund growth, and it’s common in industries like staffing and oil and gas.
- Concerns about business reputation. Some factoring companies have harmed customer relationships by aggressively collecting payments, so it’s important to research their approach before choosing one. (Find out how we treat your customers like our own.)
5 Questions to Help You Decide if Factoring is Right for You
These five questions will help you decide how much invoice factoring will help you:
- Do you need a cash injection quickly? A traditional bank loan takes weeks, and sometimes months, to process, with no approval guarantee. In fact, recent data from the Federal Reserve highlights that US banks have tightened lending standards. Meanwhile, working with a factor company can get you quick access to capital by funding invoices in a few business days.
- Do you need flexibility in when you can get funding? Lines of credit or business loans can look more flexible than they are. Traditional forms of credit exclude many types of businesses (like new businesses), require stellar credit scores to pass credit checks, and take weeks to process. Even raising the limit on an existing line of credit can be difficult. With invoice factoring, you can get funded whenever you need it, and you can do it with no credit or bad credit. (And with FundThrough, the flexibility includes unlimited funding.)
- Do you want to retain ownership in your company? Non-dilutive funding like invoice factoring ensures you never have to give up ownership in your company. But other forms of financing may require an equity stake. If you want to maintain complete control of your business while seeking quick capital for tapping into new business opportunities, then invoice factoring can be a promising option.
- Do you want to avoid debt? If you’re already carrying debt, invoice factoring won’t add to your outstanding balances since your creditworthy customer pays the factoring company.
- Do you want to be free to fund how much you want, when you want? Once your client clears their invoice payments to the factoring company, the process for invoice factoring is complete – depending on the factoring company. Some require long-term contracts obligating you to fund a certain volume of invoices, while others allow you to choose the invoices you want to fund. Make sure to look for this in any invoice factoring agreement.
Ready to see if invoice factoring is right for you?
How to Choose a Partner that Will Make Early Invoice Payments Worth It
Finally, if you’re trying to figure out whether factoring is a good idea for you, the factoring firm you choose heavily influences the value of your experience. You can get a detailed comparison of several factoring companies in our best invoice factoring companies post (also see our best accounts receivable financing companies list), but here are is our list of what to look for in any factoring company you’re considering:
- Overall cost of invoice factoring. This isn’t just about the discount rate – the percentage the factoring companies keep as their factoring fee – it also includes hidden fees. Make sure you understand the entire cost for any company you’re considering.Cost. FundThrough only charges one flat fee.
- Advance rate. This is the amount the factor advances you immediately after your approval. Some companies only advance 80% to 85% of an individual invoice and give you the rest once your customer has paid, less their fees. FundThrough advances 100% of your invoice less our fee.
- Speed. One of the most important advantages of factoring is that it’s fast. Make sure any company can give you an advance in days, allowing you to resolve immediate cash flow issues quickly. FundThrough pays invoices in days.
- Application process. What makes a simple application process? Technology. For example, FundThrough uses AI, automation, and integrations with accounting platforms like QuickBooks, OpenInvoice, and Xero to eliminate time-consuming paperwork.
- Total flexibility. Some factoring companies make you commit to factoring all your invoices for one customer, or to funding a minimum dollar amount every month, or hamper your funding with a limit. FundThrough lets you choose which invoices you want to fund with no minimum monthly funding requirements; we also provide unlimited funding.
- Clear SLAs. In your factoring agreement, make sure you know how soon you’ll receive any payments they send to your business that you choose not to get paid early.
- Dedicated customer service. It can help to have an account manager who will get to know you and your business over time, so that they can take a consultative approach, proactively working with you to ensure you have funding for any upcoming needs. Be sure to ask any factoring company you’re considering about their level of customer service.
Key Terms To Help You Find the Right Factoring Service
- Accounts Receivable Factoring – This is another term for invoice factoring: a financial transaction where a business sells its unpaid invoices (accounts receivable) to a factoring company at a discount in exchange for immediate cash.
- Debt Factoring – This is also another term for invoice factoring, but it’s not entirely accurate since factoring doesn’t create debt, as it is the sale of an asset: your outstanding A/R.
- Recourse Factoring – In this arrangement, the business remains liable if a customer fails to pay an invoice, meaning the company must buy back unpaid invoices or replace them with new ones. This type of factoring typically comes with lower fees since the factor takes on less risk.
- Non-Recourse Factoring – With non-recourse factoring, the factor assumes the risk of non-payment if the client’s customer defaults on their payments. This offers greater protection for the business but comes with higher fees since the factor takes on more risk.
Comparison: Invoice Factoring vs Invoice Financing
What’s the difference between invoice factoring and invoice financing?
- Invoice Factoring: You sell invoices to a factoring business, and they handle collections.
- Invoice Financing: You use unpaid invoices as collateral that you can draw funds against as needed, but you remain responsible for collecting payment.
Is invoice factoring worth it? The bottom line
In short, invoice factoring is worth it if you’re facing cash flow challenges. It offers a quick and straightforward way to boost your working capital. Keep in mind everything we’ve discussed to help you decide just how beneficial it could be for your specific situation.
Ready to see if invoice factoring is right for you?
FAQs
Do banks factor invoices?
Yes, some banks provide invoice factoring services, including:
- TAB Bank
- AltLINE (Southern Bank Company)
- Zions Bank
However, many businesses prefer working with specialized factoring companies that offer faster approvals and more flexibility.
Is factoring risky?
The perceived risk in invoice factoring largely depends on the creditworthiness of your customers and their payment history. If you have confidence in your clients’ ability to pay, factoring should not introduce significant risk. Non-recourse factoring can further mitigate this risk by transferring the credit risk associated with client non-payment to the factoring provider, safeguarding your business against potential losses. However, it’s often more expensive than recourse.
Should I use a factoring company?
Use a factoring company if your business needs immediate cash flow and has unpaid invoices. It works best for businesses with strong sales but slow-paying customers. Compare costs and terms before deciding.
Are factoring companies worth it?
Factoring companies can be worth it for businesses needing immediate cash flow. They provide quick access to funds by purchasing unpaid invoices at a discount. However, it’s important to shop for the best value for the fees.
About Kelli McLean
Kelli started out as the one and only account manager working with individual clients to fund their invoices, and is now Head of Revenue. She is an expert in structuring invoice factoring deals that enable small and medium sized businesses to get paid early to improve their cash flow, and is passionate about creating a “can-do” team culture that encourages account executives and managers to find creative solutions for funding clients.