Do your customers take 30, 60, or 90 days to pay? Such lengthy payment cycles can make day-to-day operations a constant struggle. Worse, many business owners have to dip into their personal funds to fulfill orders on time, meet payroll, and pay suppliers. Good thing, factoring companies offer quick and easy funding to solve these problems, all without monthly interest or tedious paperwork.
With factoring, business owners like you can sell unpaid invoices to a third-party factor for an instant cash advance. The result? You inject cash into your business right away, get rid of exhausting collections, and enjoy a steady cash flow. What’s not to like?
In this post, we discuss more about how factoring companies work, how they differ from traditional funders, and how you can get started. Keep reading to learn more about this game-changing financing option!
Understanding Invoice Factoring: From Concept to Implementation
Invoice factoring has been widely used across industries for many years. Contrary to misconceptions, factoring isn’t exclusive to big players – even startups and small businesses can also take advantage of this financing solution.
Below, we discussed how factoring works and why it could be a better choice than other alternative funding options.
What Is Invoice Factoring and How Does It Differ from Traditional Financing?
Invoice factoring is the process of selling accounts receivable to a factor in exchange for an instant cash advance. Most factoring companies can advance 80% to 98% of your invoice value, depending on specific factoring terms.
Unlike bank loans, factoring doesn’t incur interest rates or monthly payments. It often involves one-time fees, either fixed or variable, which you pay once the factor successfully collects your invoice.
Also, it’s important to note that invoice factoring is different from invoice financing. With invoice financing, your business retains responsibility for collecting the funded invoice. At the same time, you keep the credit risk with invoice financing, and interest is charged on the amount borrowed, much like a traditional loan.
But with factoring, you transfer the collections to the factor, and you can opt for non-recourse terms to minimize credit risk in case of customer insolvency.
Overall, factoring can be a complementary solution with other financing options you already have in place for your business. For example, funds from factored invoices will keep your lines of credit intact for more important purchases. If used correctly, factoring can also complement your existing business loans by giving you steady funds for loan servicing.
The Step-by-Step Factoring Process Explained
The factoring process is simpler and more straightforward than traditional financing options. Here’s a step-by-step guide on how you can convert invoices into cash through factoring:
Step 1. Issue the customer invoice
Bill your customer as usual and prepare all necessary supporting documents after completing the goods and services.
Step 2. Submit an invoice for factoring
Once you’ve issued a valid invoice, send us a copy, and we’ll start the factoring process. Make sure you send us the proof of completion, rate confirmation, bill of lading, and other supporting documents.
Step 3. Undergo invoice verification
Our team will verify the eligibility of your invoice by ensuring it doesn’t have any liens, pledges, or disputes. We’ll also check the credit history of your customer to ensure that they can pay the factored invoice.
Step 4. Receive instant invoice funding
Once your invoice is verified, you’ll receive a percentage of its value as a cash advance. Factors like Factoring Express LLC will send it to you via ACH transfers or check, whichever you prefer.
Step 5. Factor collects your invoice
While you maximize your instant funding, the factor will send a Notice of Assignment (NOA) to your customer, informing them of the factored invoice and the new payment scheme. The factoring company will collect the invoice until it’s fully paid.
Step 6. Receive final payments
After your customer pays, the factor will send you the remaining balance minus their small factoring fee.
Step 7. Repeat for effortless funding!
Simply repeat the factoring process on any eligible invoice to keep cash flowing with every new order in your business. You can also factor invoices in bulk if you prefer fast funding instead of chasing down payments for weeks.
Key Types of Factoring Arrangements for Different Business Needs
There are several types of arrangements under general factoring. Knowing their differences, benefits, and disadvantages will help you choose which terms suit your business best.
Below, we discussed two main types of factoring arrangements: 1) based on credit risk and 2) based on invoice volume.
Recourse vs. Non-Recourse Factoring
Factoring arrangements could differ based on who assumes the risk in case the customer fails to pay the invoice. This can either be recourse or non-recourse, depending on what your business needs.
With recourse factoring, your business assumes credit risk if the factor fails to collect the invoice. You may have to buy back the factored invoice or replace it with a new one, depending on the inclusions of your factoring contract.
On the upside, recourse factoring has lower fees since your business bears some level of risk. Also, factoring companies conduct rigorous credit checks and due diligence to minimize recourse risks.
Meanwhile, non-recourse factoring is when the factor assumes the credit risk in case of failed collections. The factor will simply declare the uncollected invoice as a loss. However, this type of factoring has higher fees as the factor has to shoulder much of the financial risk.
Both recourse and non-recourse factoring work for a variety of businesses. If you want to learn which works best for your business, you can consult with a local factoring company like Factoring Express LLC for professional advice!
Selective vs. Whole-Ledger Factoring
Another type of factoring arrangement is based on the invoice volume a business factors. This can either be selective or whole-ledger factoring, both of which vary in scope, control, and cost.
With selective factoring, your business gets to choose which invoices you want to factor and when. For example, you can factor slow-paying clients and keep the rest of your ledger on your in-house collections team. You can also factor high-value invoices to receive much-needed working capital tied to them.
However, selective factoring has its share of downsides. It can be complex for businesses to track selectively factored invoices, which adds to their staff’s bookkeeping tasks.
Meanwhile, whole-ledger factoring involves selling your entire accounts receivable ledger to a factor. All your unpaid invoices will be factored, giving you predictable and reliable cash flow even when customers take time to pay. At the same time, you’ll outsource the entire collections to a professional team, freeing up your staff from the tiring administrative task.
Still, whole-ledger factoring isn’t suitable for all businesses. Since you’re selling all your ARs, you lose control over how collections will be handled. Also, some businesses may have confidentiality concerns when committing their entire accounts receivable to a third-party company.
So, which factoring arrangement is right for your business? Overall, if you only need occasional cash flow boosts, selective factoring might be a smarter option. However, if you consider fast payments paramount, then whole-ledger factoring might be what your business needs.
How Factoring Transforms Business Cash Flow and Operations
No business is immune to delayed customer payments. But instead of letting the lengthy payment cycle hold you back, you can use factoring to bridge the cash flow gap. Here’s how:
Immediate Financial Impact and Working Capital Improvement
Through factoring, you can convert receivables into same-day cash. It eliminates uncertainty on your cash flow, allowing you to plan business growth more confidently, knowing you have the funds to back it up.
At the same time, factoring offers scalable funding for your business. Factors like Factoring Express LLC have up to $100 million in funding capital, allowing you to sustain and expand your business with funding that grows with you.
With sufficient working capital, you can channel funds to various business opportunities, such as hiring more staff, acquiring new equipment, and opening more service areas. All of which would be otherwise challenging to accomplish if you rely on traditional collections.
Operational Benefits Beyond Funding
Aside from injecting cash into your day-to-day operations, factoring also offers back-end support to your business.
For example, many factors offer accounting and bookkeeping services to help you keep track of your revenue. This professional AR management solution ensures that all invoices are accounted for, funded, and collected on time.
Moreover, factoring services reduce your staff’s administrative burden by shouldering the collections process. This is a huge relief for small and medium businesses (SMBs) who have limited manpower and often have to juggle different roles to maintain their operations.
On top of that, factoring companies also provide free credit checks to help you assess which of your customers are at high risk of non-payment. This way, you can make informed decisions about which orders to accept and which ones to turn away. Also, these credit checks reduce the risk of recourse terms.
Factors like Factoring Express LLC also provide your own client portal where you can check customer credit, paperwork, and aging reports. You’ll also receive an annual report for tax purposes, making your business accounting much easier.
Industry-Specific Factoring Applications and Advantages
Factoring has proven to be a helpful financial tool for industries known for their lengthy payment cycles. Below, we discussed some of these industries and how factoring helps resolve the financial woes brought by slow payments.
Transportation and Logistics Factoring Solutions
Freight invoices often take 30 to 90 days to get paid. However, fleet managers and owner-operators don’t have the luxury of time to wait for customer payments. Every day, they need funds for fuel, driver salary, maintenance, and more to keep their trucks on the road.
By selling their freight bills to factors, transportation and logistics companies will have immediate access to their much-needed cash. It can also be in the form of fuel advances, where a percentage of the upcoming invoice is given as a cash advance to be paid after delivering the load.
At the same time, many factoring companies also offer fuel cards where drivers can get discounts on thousands of in-network locations throughout the United States.
Healthcare Provider Factoring Arrangements
Healthcare practices often deal with lengthy reimbursement cycles from insurance companies and government payers, which pose gaps in their revenue cycle.
Overall, it’s not uncommon for healthcare organizations to wait for 60 to 120 days to receive full reimbursements. During this delay, practices have to continue providing healthcare services, which can be challenging when their capital is tied to unpaid claims.
Instead of struggling with delayed payments, practices can sell eligible claims to a factor for instant funding. They will receive a percentage of their medical receivables that would otherwise remain in collections for months.
How about patient confidentiality? Medical factoring companies are compliant with HIPAA regulations to protect your patients’ privacy during collections.
Construction and Contracting Factoring Structures
The construction and contracting industry has a complex cash flow cycle. Due to the length of construction projects and multiple parties involved, payment collection can drag on for months. For contractors, this means one thing: payment delays that could cost them profitable contracts.
Aside from that, contractors have to continue paying rent, buying materials, and covering overhead costs. But if invoices remain unpaid, they would be forced to go out of pocket with expenses or open another bank loan.
But by factoring their construction invoices, contractors will receive instant cash to meet their financial obligations. Also, it will give them enough working capital to accept new projects without the threat of delayed payments.
Staffing and Professional Services Factoring
A steady cash flow is crucial in running a staffing company. After all, staffing agencies have to cover payroll regularly and recruit new talent for their clients. However, delayed payments cause timing gaps between paying employees and receiving cash from unpaid invoices.
When this happens, staffing firms will exhaust their lines of credit or apply for new bank loans to cover their financial obligations. While these can tackle short-term cash flow problems, they will not resolve recurring payment delays.
This is where staffing factoring comes in. By selling their unpaid invoices, staffing agencies can get a cash advance they can use for various expenses without the long wait.
Essential Evaluation Criteria for Selecting a Reliable Factoring Company
While factoring is an effective solution for cash flow gaps, the choice of a factoring company can be a make-or-break part for your business. To make sure you’re partnering with a reliable factor, you should consider the following aspects first.
Experience, Stability, and Reputation Assessment
Consider partnering with factoring companies that have been in the industry for years. Not only is it proof of their funding stability, but also of their sustainability as a partner for your business’ growing invoice needs.
Aside from that, check the factor’s reviews for firsthand accounts of their actual clients. This will help you assess how well they work with businesses and what kind of companies they have experience with.
At the same time, check the factor’s specialization. Some factors specialize in specific industries like healthcare, transportation, and contracting, while others may offer more comprehensive funding options.
For example, if you’re running a medical practice, you should look for a HIPAA-compliant factoring company. Or if you’re a fleet manager planning to sell freight invoices, look for a factor who has extensive experience working in the logistics industry.
Above all, make sure that your choice of factoring company is a bona fide member of the International Factoring Association (IFA). IFA is an association providing training, education, networking, and promoting ethical standards among licensed factors.
Financial Terms and Structure Comparison
Factoring companies offer varying rates, so make sure you inquire first to ensure that they suit your budget.
In general, factoring companies charge either a fixed rate or a variable rate. With a fixed rate, you’ll pay a predetermined percentage of your invoice, regardless of how long it took to collect. Meanwhile, variable factoring rate is a fee structure that increases as your invoice goes unpaid.
If your customers tend to pay on time, a variable factoring fee can be more cost-efficient than a fixed rate. The right choice depends on your unique needs, invoice risk, and the amount of invoices you wish to fund.
Aside from fees, you should also check the terms of your factoring agreement. Check if the factor imposes minimums, termination fees, or a lengthy commitment duration. From there, you can decide whether the factoring company is suitable for your business.
If you prefer flexible funding, consider partnering with Factoring Express LLC. We don’t have monthly minimums or long-term contracts. You can choose the invoice you want to factor and when you need it. Also, we don’t charge termination fees – you’re free to cancel anytime!
Understanding Factoring Costs: Complete Fee Structure Analysis
While factors offer instant funds, it also comes at a cost, the main concern of businesses when selling their accounts receivable. Take note that factoring fees can vary widely depending on the provider, industry, invoice quality, and contract terms.
To learn more about the factoring fee structure, we explained the main points you need to know below.
Primary Fee Components Explained
When factoring an invoice, you should expect the following fees and charges:
Discount Rate (Factoring Fee)
The discount rate is the primary fee charged by your factor, usually as a percentage of your invoice value. It covers the cost of advancing money and collecting the invoice from your customer.
For example, if your invoice is $10,000 and the discount rate is 2%, you pay $200 in fees. This fee is typically calculated on the invoice amount and can be charged monthly or as a flat fee.
On average, discount rates fall between 1% to 5%, depending on your invoice quality.
Advance Rate
Though not a fee, the advance rate affects your effective cost because it determines how much cash you receive upfront. In general, advance rates range from 70% to 98% of your invoice value.
A lower advance rate means you wait longer for the remaining balance after your customer pays, which can affect cash flow. Meanwhile, a higher advance rate will inject more cash into your business, but often with a higher discount fee.
Reserve Account (Holdback)
Factors hold back a portion of the invoice amount (the reserve) until your customer pays in full. This reserve acts as a cushion against disputes or non-payment, ranging from 5% to 30% of your invoice value.
Once the factor collects full payment from your customer, the reserve will be released to you, minus the factoring fee.
Additional charges
In some cases, you may be charged extra fees for returned checks, wire transfers, or late payments. The amount of these additional charges varies across factors and will be detailed in your factoring contract.
Identifying and Avoiding Hidden Costs
Legitimate factors outline all fees and charges on your factoring agreement. Still, you should watch out for these hidden costs to avoid unwanted surprises:
- Monthly minimum fees. Some factoring companies require a minimum fee per month regardless of your invoice volume. This means if you factor less than a certain amount, you still pay the minimum fee, which can be costly for small businesses.
- Setup fees. There are factors that charge a one-time fee for setting up your account or processing your application. Always watch out for this fee as it may not be disclosed during the initial quote.
- Late payment penalties. Some factors charge businesses with late payment penalties under a recourse factoring agreement.
- Early termination fees. Some factoring contracts include a termination fee if you decide to end the agreement before the set period.
Technology Platform and Accessibility Evaluation
When you sign up with Factoring Express LLC, you’ll have access to our exclusive client portal where you can manage all documentation, ARs, aging reports, and more in one place. Here’s a quick preview of what you can expect:
Critical Portal Functionality Features
Through our client portal, you can take advantage of the following functionalities:
- Online invoice submission. You can easily submit invoices to our online portal for fast and paperless factoring. You can send invoices individually or in bulk.
- Real-time payment updates. You can also see real-time updates on your factoring requests, including which invoices are pending, approved, funded, or paid.
- Customer credit checks. Inside our factoring portal, you’ll also access credit reports from various credit bureaus to get insights about your customers.
- Secure document sharing. Our encrypted platform protects confidential documents and customer information in compliance with various industry regulations.
- Customer support. If you have any questions or concerns, you can reach out to us 24/7 through our online customer support.
Reporting, Analytics, and Integration Capabilities
Aside from the basic factoring features, our client portal also has the following integrations:
- Accounting software integration. Connect your data to popular platforms like QuickBooks or NetSuite for hassle-free accounting management. You can also download and export your data to any platform of your choosing.
- Custom reports. Get custom reports for tax or internal purposes, including customer segments, invoices, date ranges, and more. You’ll also receive accurate reports of your aging ARs.
Conclusion
If you’re ready to convert unpaid invoices into cash, contact us at Factoring Express LLC. We offer comprehensive factoring services tailored to the unique needs of your business.
With our factoring service, you can get instant cash advances in as little as 24 hours. No long-term contracts or monthly minimums. Reach out today to unlock same-day funding and a 1-week free trial!
FAQs about factoring
Do I lose control over my customers when I factor their invoices?
Despite factoring in their customers, you’ll still maintain a good customer relationship. In fact, factoring will let you extend better payment terms to your clients, which will be beneficial in the long run. The only thing you’ll lose is the hassle of collections and long payment cycles!
Are all invoices eligible for factoring?
Not all invoices are eligible for factoring. At Factoring Express LLC, we only accept B2B and B2G invoices with no liens, disputes, or pledges. To verify if we can fund your invoice, contact us today for a consultation.
What happens if my customer disputes an invoice?
At Factoring Express LLC, we maximize all professional means to collect your invoice. In the case of invoice disputes, we’ll ask the issuing business to resolve it first before we can proceed with factoring.
Is factoring confidential?
There are two factoring arrangements: confidential and disclosed. Disclosed factoring is the most common, where your customer receives a Notice of Assignment (NOA), informing them of the factoring setup and the new payment scheme. It’s widely used for large B2B transactions and has lower fees than confidential factoring.
Can I factor all my invoices or only some?
You can always choose between selective and whole-ledger factoring, depending on what you think suits your business best. Some businesses opt for selective factoring to bridge occasional cash flow gaps. Meanwhile, some businesses sign up for whole-ledger factoring for a consistent cash flow without the hassle of in-house collections.
What industries might not be suitable for factoring?
Factoring may not be suitable for retail businesses with mostly cash sales and credit invoices. Also, businesses in B2C industries may not qualify for factoring since they issue invoices to individuals rather than other businesses or organizations.
What happens if my customer goes bankrupt after factoring?
Bankruptcy means the factor can no longer collect the invoice. If your customer goes bankrupt after factoring their invoice, there are two potential outcomes, depending on your factoring arrangement. First, you’ll have to buy back the invoice under recourse terms. Or second, the factor absorbs the loss under non-recourse terms.
Can I use factoring if I have bad credit?
Yes, factoring funds unpaid invoices based on the customer’s creditworthiness, not your business. Startups and small businesses that are still building their credit history can benefit from factoring. The same goes for businesses still reeling from bad debt. As long as your customer has good credit, you can get instant funding on their unpaid invoice.
How do factoring companies verify customers?
Factoring companies conduct thorough credit checks to reduce the risk of non-payment among invoiced customers. They also verify the accuracy and authenticity of the invoice, ensuring it has no disputes or liens. Once verified, the factoring company will proceed with funding the invoice.
