Invoice Factoring
Invoice Factoring is the selling of accounts receivables to free up cash flow. When Invoice Factoring, the business will receive an advance that’s typically 80% of the invoice amount at the point of purchase. Once the invoice is collected, the business owner gets the remaining 20% less a fee.
What Is Invoice Factoring?
Invoice Factoring is a way to free up cash flow that’s held up in your unpaid invoices. Typically, the company will collect the payments on the business’s behalf.
We’re going to go over using Invoice Factoring to fund your small business in detail in this guide. We break down everything you need to know about this type of small business loan so that you can decide whether or not it’s the right move for your business.
The Math Behind Accounts Invoice Factoring
Let’s look more closely at how accounts invoice factoring works. After all, you want to be 100% comfortable with the process and be aware of how it will work for your business.
Invoice factoring companies will buy your receivables for 50% to 90% of the total invoice value. Then, your customers will pay their invoices, in full, directly to the factoring company.
Lenders will typically take a processing fee, usually around 3%, on the invoice amount. They’ll also charge a “factor fee” each week until the invoice is paid, usually around an additional 1%.
Note that some lenders offer “non-recourse factoring,” meaning that they assume the credit risk of non-payment. Other lenders reserve the right to “recourse” on bad debt, meaning if your client does not pay, they will ask you to repurchase the invoice. The lines can get a bit blurry here, so make sure to check the fine print.
Example of Accounts Invoice Factoring:
To get a better picture of how accounts invoice factoring works, here’s a real-world example of a factoring transaction:
Say you have $200,000 on an outstanding invoice with 30-day terms. If you’re like any other small business owner, you’re probably too busy to collect your outstanding invoices, but you also can’t afford to get behind on your cash flow.
To take your unpaid invoice off your hands, you approach an accounts invoice factoring company. The factoring company buys your outstanding invoice for 85% of the invoice value and holds the remaining 15%, meaning you’ll see $170,000 in your bank account while the lender keeps $30,000.
Right off the bat, the lender charges you a 3% processing fee, or $6,000. It takes two weeks for your customers to pay up, so you end up paying a 2% factor fee—or $4,000. The lender keeps $10,000 of the $30,000 reserve, and you’ll get $20,000 back.
Advantages and Disadvantages of Invoice Factoring
The Advantages
Invoice factoring is a great option for some companies, but it isn’t always the right solution for your small business.
Before you commit to a factoring receivable agreement, be sure to weigh the pros and cons of invoice factoring.
Accounts receivable financing will have different benefits for different companies, but in general, here are the primary advantages:
- Fast Access to Cash: There will come a time in the lifespan of your small business when you’ll need a quick infusion of working capital. You might need to cover unexpected costs, or seize a new business opportunity before time runs out. Luckily, there are a few business loans for you to consider. Invoice Factoring is one of them. Every situation will be different, but you can sometimes get funds in exchange for your outstanding invoices within one business day. Traditional business loans—especially bank loans—can take several weeks to be approved. If you’re in a time crunch and you need cash from your invoices as soon as possible, factoring might be preferable to a traditional bank loan. Bank loans, though, involve one less party since they’re just between you and your lender.
- Invoices Serve as Collateral: Invoice factoring is technically a type of asset-based loan. An asset is a thing your business owns—a piece of equipment or machinery, a vehicle, or a selection of your inventory. With the traditional small business loans that you’re probably most familiar with, lenders determine what you qualify for based on your borrowing and business history—like your credit score, tax returns, bank statements, and more. With asset-based lending, lenders rely on the value of the asset, which acts as collateral for the loan. What does this mean for your business? With Invoice Factoring, you won’t need to put up any extra collateral for your loan. If something goes wrong, the factoring company can always collect on the invoice to recover their losses.
- Easier to Qualify For: When applying to traditional small business loans, you almost always need to provide a lot of information and documentation about your business before you’re approved. Without fail, lenders will scrutinize your personal credit score, financial health, and business history. So if you have a less-than-ideal credit score or you haven’t been in business for a long time, you won’t be eligible for many of the small business loans out there. With Invoice Factoring, lenders are really only concerned with your outstanding invoices. They’ll want to make sure that taking on your accounts receivable is a smart investment. But otherwise, lenders don’t care as much about your credit rating or business history—making invoice factoring a great option for small businesses that don’t qualify for other loans.
- Ability to Outsource Invoice Collection: Not every factoring company will take on your debt and collect your accounts receivables for you. But, the ability to outsource your collection can be a big advantage for a lot of small business owners. If your business is having a particularly busy season, you may not have time to reach out to late-paying customers over and over again. Or, you might run a very small business and you don’t have the internal manpower to collect invoice payment in an efficient manner. If a factoring company takes over the collection of your accounts receivables, you can focus on the other parts of your business that are more important to your success.
The Disadvantages
When you’re considering any small business loan, you should be aware of the potential downsides to the business financing option. The same goes for invoice factoring.
Here are some disadvantages associated with invoice factoring:
- Higher Fees Than Traditional Financing: As small business loans go, accounts receivable financing is an expensive way to finance your business. With factoring, you can get access to money in a hurry. However, fast cash is expensive cash, and invoice factoring is no exception. Accounts invoice factoring will come attached with some of the highest fees around. When you take the 3% processing fee and the 1% per week factor fee, you’re looking at paying at least 4% for money lent for a short period of time. These fees are steep, but if you’re tired of waiting on your customers and you need money to meet payroll or to pay off your suppliers, invoice factoring could be worth the price. Before you commit to a factoring agreement, though, be sure you fully understand the factoring rates, fees, and other costs
- Giving up a Portion of Your Profits: Invoice factoring isn’t that complicated of a process: You receive instant money for your outstanding invoices in exchange for a portion of your profits. Whenever you use invoice factoring, you won’t fully receive what your customer owed you originally. If your customer owes you $100,000 on an invoice, you’ll part with at least $4,000. The question to ask yourself before you commit to accounts invoice factoring is: Are you willing to part with $4,000 to access the other $96,000 right now? If the answer is yes, then invoice factoring could be right for you. If you aren’t as willing to give up any of your profit, then you should pursue other forms of business financing.
- Slow-Paying Customers Impact How Much You Owe: Another downside of Invoice Factoring is that the longer you have to wait for your customer to pay the invoice, the more you will owe the factoring company—typically, your factor fee will be 1% each week the invoice is outstanding. So if it takes a customer six weeks to pay, you’ll end up paying 6% in factoring fees. If you’re confident your customers will pay up in one or two weeks, then the factoring fee won’t hurt too much—especially if the invoice is large in the first place. But, reviewing how quickly your customers have paid in the past will help you decide whether invoice factoring is the right move for your business. It will also help you decide which client invoices to sell. In general, it makes the most sense to sell invoices associated with customers that usually pay quickly and in full. When a factoring company takes over the collection of your invoices, don’t be surprised if the company wants to know where your customers’ credit scores stand. Lenders won’t want to advance you cash if they have reason to believe that your customers aren’t likely to pay their invoices.
- Customers Are Aware That Your Business Is Invoice Factoring: Before you commit to an accounts invoice factoring agreement, make sure you’re comfortable with inviting a third-party company into your relationship with your customers. If a factoring company takes over the collection of your accounts receivables, there’s no hiding the fact that you’ve entered into a factoring agreement. This might indicate to the customer that you’re having financial trouble. You might not see much value in continually late-paying customers anyway, but what about your other customers? Word might get out that your business is struggling, and you might lose existing customers or scare off future ones.
How To Apply
Our application process is fast and easy, taking just a few minutes to complete, and funds can appear in your bank account in as few as 1-2 business days from approval. Here is how to apply:
Step 1: Contemplate Your Needs
Before you apply, make sure that the funding program is the right solution for your business’s needs. Consider whether you will be able to use the funds for your desired purpose, and if the repayment structure is conducive to your cash flow. Take your time to determine the amount of funding your business will most benefit from.
Step 2: Collect Your Documents
Here is what you will need to submit with your application:
- A valid driver’s license
- 1 voided business check
- Last 4 months of bank statements
- Last 4 months of credit card processing statements
Step 3: Fill Out Our Online Application
To start the application process, give us a call or fill out our short online application. We will ask you to provide some basic information, along with your desired funding amount.
Step 4: Speak to a Representative
Once you apply, a representative will reach out to you, so make sure you have all your documents ready from ‘Step 2’. The representative will explain the repayment structure, rates, and terms you qualify for. This will ensure that there are no surprises or hidden fees during repayment. Once you decide, you will be given a final application to submit along with your documents.
Step 5: Receive Approval
If you’ve been approved, you’ll hear back from us within 24 hours. Funds should then appear in your bank account in 1-2 business days.
What If I'm Declined?
Your application may be declined if your business’s cash flow is insufficient at the time of your application. This product places an emphasis on monthly revenue, so applicants with strong sales in the previous 4 months are more likely to receive approval than those without. You may also be asked to provide statements going back farther, even from a previous year.
In some cases, we may conclude that taking on more debt would do more harm than good for your business. In this case, we might recommend a different, more affordable business financing tool. At Allenby, we can help you explore your options and point you in the direction of the most sensible choices.
How to Get Funding
Follow our easy 3-step funding to get cash into your account within 24-48 hours.
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