Invoice factoring, also called receivable financing, is essentially selling your outstanding invoices to a factoring company. Instead of waiting for your customers (usually other businesses) to pay your invoices, you get paid upfront. And you have the funds to keep your business moving forward.
Invoice factoring can be beneficial, especially for startups or new businesses. When it comes to business financing, traditional lenders and financial institutions prefer to deal with established businesses. This makes it difficult for small business owners to secure loans.
Thankfully, there are alternative forms of financing, like invoice factoring, that businesses can use to get quick access to working capital. Keep reading to discover what invoice factoring is and how it works. We’ll also discuss some of its benefits and tell you how to secure this type of loan with Clarify Capital.
What Is Invoice Factoring?
Invoice factoring is a type of invoice financing that lets you borrow money with your unpaid invoices as collateral. So, it’s not technically a loan but more like a cash advance. Invoice factoring is selling your invoices at a discount to a factoring company.
You receive a lump sum of cash anywhere from 80% to 100% of the total invoice value. You sell your invoices for a discount to a third party. The factoring company pays you an agreed-on amount upfront, and then it gets paid when it collects from your customers. Any remaining amount minus fees is paid to you once the invoice clears.
Invoice factoring as a financing option is typically only available to businesses owners whose customers are other businesses. This is because it’s easier for factoring companies to check the creditworthiness of businesses than individuals. Also, businesses buy more, so the invoices involve larger amounts of money compared to the expenses of a household.
The advantage of invoice factoring is that lenders are more concerned about the credit rating of the customers. So, there’s no personal credit requirement for small business owners. And the application process is quick, which helps businesses receive immediate funding to pay their bills and keep operating.
What Is an Invoice Factoring Rate?
The invoice factoring rate is the discount rate used to calculate factoring fees. The advance rate is usually between 0.5% to 5%. Every borrower’s rate is different depending on the terms of the factoring agreement. And it’s worth noting that invoice factoring costs vary based on the industry and type of business.
Each factoring company also uses a different fee structure. The two most popular options are the “flat rate” and the “flat discount plus margin.” For example with a flat fee, you’d be charged a 2% to 3% fee every 30 days. On the other hand, if you agree to a flat discount plus margin, factoring companies might charge a 0.5% fee every 30 days plus an interest rate of 2% to 3%.
Make sure you understand the terms of your contract. Invoice factoring services can involve additional fees, such as factoring company charges for credit checks and other administrative charges.
What Determines the Factoring Fee?
Lenders base the factoring rate on your sales volume, your customers’ creditworthiness, the invoice amount, and how long it takes customers to pay. Sales volume refers to the number of customers you have.
Often, invoice factoring may not work for businesses with only a handful of customers. This is because factoring companies prefer to spread their risk as widely as possible — they want to avoid a high concentration of invoices to just a few customers. So, your contract may include a minimum volume requirement for a specific amount within a given period.
Payment terms refer to the agreed time frame your customers have to pay you after you’ve invoiced them. Common payment terms are 30, 60, and 90 days.
The discount rate also depends on whether you’re entering a “recourse” or a “nonrecourse” factor. With a recourse contract, any unpaid invoices are your responsibility. It means you’re obligated to buy them back or replace them with a current receivable.
But in nonrecourse factoring, the risk is on the lender if a customer doesn’t pay. This is why nonrecourse contracts have higher discount rates — the lenders have to account for the risk of not getting paid.
An Invoice Factoring Example
In this example, we’ll explore how invoice factoring works. Say you own a plumbing business where you provide services for construction companies. You’re typically paid within 30 days of submitting your invoices and you’re waiting on $10,000 of accounts receivable.
Say you need extra cash to repair the company vehicle and make payroll next week. Your financing needs are urgent, and there’s no time to apply for a business loan from a lender. So, you look at invoice factoring loans, a factoring company agrees to buy your unpaid invoices for $9,750. Calculated as $10,000 less the factoring fee of 2.5%, which is $250.
The invoice factoring company advances 90% of the invoice total. So, you receive a cash advance of $8,775 ($9,750 x 90%). When the invoices come due, the factoring company collects from your customers. They pay you the remaining balance of $975 ($9,750 - $8,775).
Benefits of Invoice Factoring
A business needs steady cash flow to fund its day-to-day operations like paying rent, employees, and buying inventory. Many businesses whose customers are other companies typically sell on credit. But businesses run into cash flow problems because the credit periods are long or the customers pay late.
For small businesses that need fast cash, invoice factoring comes in handy. The requirements are less strict than business loans, and the application process is quicker. Below are other advantages of invoice factoring.
Instant access to capital:
Invoice factoring is a great way for your business to receive funding immediately without taking on debt or giving up business equity. Access to fast cash lets you cover cash flow gaps and keep operations going smoothly.
High approval rates:
Your chances of finding a factoring company to buy your accounts receivables are higher than getting approved for a traditional loan from a bank. Third parties don’t need to check your personal credit score for this type of financing, so it’s a great option if you have a less-than-stellar credit history.
No collateral needed:
In an invoice factoring contract, your accounts receivables serve as collateral for the loan. So, you won’t have to provide other forms of collateral, such as inventory, equipment, or real estate that the factoring company can seize if you fail to pay.
Improved customer relationships:
Through invoice factoring, you can still have the cash you need in time to meet your financial obligations. But you can keep loyal customers on longer payment terms without sacrificing your cash flow.
Flexible financing terms:
The cost of factoring services can be easily justified if you consider sales lost due to low inventory or fees incurred from late bill payments. Don’t spend your time chasing customers for their unpaid invoices. Use invoice factoring to get funds and keep your operations going smoothly. Building a relationship with a factoring company also means access to more money if your sales volume increases.
Let Clarify Capital Help You With Your Invoice Factoring Needs
At Clarify Capital, we believe that our success depends on your success. That’s why we strive to offer the solutions you need for your business. And we work with 75+ lenders to get you the best rate.
We aim to exceed your expectations, so we keep things simple, convenient, and transparent. When you finance with us, you have a dedicated Clarify advisor who will walk you through the whole process. Your advisor will help you choose the best option based on your business goals.
Fill out an online application or talk to a Clarify advisor today about your invoice factoring needs. Once you’re approved, you’ll get access to your capital in as little as 24 hours!