Invoice factoring is an innovative business financing solution that allows businesses to unlock the value of their invoices in order to obtain working capital.
Simply put, it’s where your business sells its accounts receivable (invoices) to a third party, known as a factor, at a discount. The factor then becomes the primary creditor and collects the payments on behalf of your business from your customers.
There are numerous benefits to invoice factoring, and we’ll go through it all — including how to get up and running — in this short guide.
Let’s get started!
Two women discussing invoice factoring
Benefits of invoice factoring
Technically, invoice factoring is similar to a rapid business loan — except one that uses your accounts receivable as collateral.
But unlike traditional loans, invoice factoring doesn’t require you to go through a lengthy application process or put up your personal assets as collateral.
This makes it an ideal financing solution for businesses that need quick access to cash, or companies that routinely need to but may not meet the stringent requirements of a bank loan. Freelancers or sole proprietors that make their own 1099s are less likely to need invoice factoring, but depending on the turnaround time with which they receive payments, may want to look into it all the same.
Businesses that typically factor their invoices
There are many industries where invoice factoring is popular, but some of the most common include:
1. Manufacturing
2. Wholesale
3. Transportation and logistics
4. Construction, and
5. Professional services
Each of these industries have one thing in common: they often have to wait a long time to get paid by their customers. This is because the customers in these industries are usually larger businesses that take longer to pay their invoices.
This is where invoice factoring can be so useful. It allows businesses in these industries to get paid sooner, which can be a huge help in managing their cash flow.
A woman and a man looking over business tax documents and financed invoices
Key benefits of invoice factoring
Here are some of the key benefits of invoice factoring:
1. Instant access to cash
Once you’ve sold your invoices to the factor, you’ll receive an immediate infusion of cash into your business. This can be a lifesaver for businesses with long turnaround times or that are waiting on payments from customers.
2. Improved cash flow
Factoring allows you to get paid sooner for the goods and services you’ve already provided. This can help to improve your company’s cash flow, which is essential for keeping your business running smoothly and investing in new growth opportunities.
3. Increased flexibility
Factoring doesn’t require you to take on any new debt, and there are no fixed monthly payments. This gives you the flexibility to use the funds however you see fit — whether it’s to cover day-to-day expenses, make new hires, or invest in new equipment or technology.
4. Improved credit score
One of the key benefits of factoring your invoices is that it can help to improve your business’ credit score. This is because the factor will report your account activity to the major credit bureaus, which can help to demonstrate your company’s financial stability and creditworthiness.
5. Tax benefits
Factoring can also offer tax benefits for businesses. For example, the interest payments on the factor’s loan may be tax-deductible, and you may be able to offset the income generated from invoice factoring against your company’s taxable profits.
How to start invoice factoring
The simplest way to start invoice factoring is by contacting a factor directly. Factors can be found through a quick online search, or you can ask your accountant, banker, or other business contacts for referrals. Some notable factors in the US include BlueVine, Fundbox, and invoice.com.
Once you’ve found a factor, the next step is to complete an application. This will include information about your business, such as its size, credit history, and customers. The factor will also require copies of your most recent financial statements and invoices.
If your business is approved, the factor will purchase your invoices at a discount and become the primary creditor to your customers. You’ll then receive a percentage of the invoice amount (usually 80–90%) in cash, which can be used to cover day-to-day expenses or reinvest back into your business.
Lastly, though invoice factoring is not a loan, it’s important to remember that it does come with some costs. These include an up-front fee (which can range from 1–5% of the invoice amount), as well as a monthly service fee (usually around 1%).
Despite these costs, invoice factoring can be a great option for small businesses looking for fast and easy access to capital. It’s a quick and simple way to get cash flow relief, without the hassle of traditional loans.
In closing
In summary, invoice factoring is a great way for businesses to get cash flow quickly and easily. The process is simple and straightforward, and can provide your business with the liquidity it needs to grow and succeed.
