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What is invoice factoring and receivable financing?

Business owners have many options when it comes to aiding short-term cash flow problems.

However, invoice factoring (sometimes referred to as accounts receivable factoring) shines as a unique and convenient option for business owners who don’t want to take out a loan to keep their business running smoothly.

As opposed to acquiring debt through a loan, factoring allows business owners to use the accounts receivable they already have to obtain the cash they need now for everything from payroll to paying off vendors.

If accounts receivable factoring sounds like it could be the right choice for you and your business, read on to find out more about how it works, how and when factoring is useful compared to a traditional loan, and much more.


What is invoice factoring and how does it work?

Accounts receivable factoring is a financing option that is designed primarily for B2B small businesses that use invoicing to collect payments.

If you’re familiar with PayPal Working Capital, it operates similarly to that but with some important differences.

With factoring, your invoices are sold to a factor in exchange for working capital now to fund any number of business expenses or investments.

Typically, the factor will advance you between 70-85% of the total invoice amount immediately along with the remaining 15-20%, minus fees, upon receiving payment for the invoice from your customer.

Once your invoice or invoices are sold to the factor, they will communicate directly with your customer to collect the invoice payment.

Not to be confused with invoice financing (also called accounts receivable financing), with accounts receivable factoring, you’re selling your invoices and receiving cash in return, while with invoice financing, you’re using your invoices as collateral to obtain capital.

We’ll talk more about the difference between invoice factoring and invoice financing later. First, let’s talk a bit about how factoring works, how to qualify for it, and how it can help your business.

What is accounts receivable?

When it comes to factoring, your accounts receivable is the single most important element of all.

Accounts receivable is defined simply as the total amount owed to your business from those who owe you (your debtors). In other words, if you’ve billed your customer with an invoice and that invoice is currently open (you have not received full payment and there is still some or all of the invoice to collect), it’s a part of your accounts receivable.

Factoring is entirely based on your accounts receivable because it uses that debt as a kind of soft collateral to collect the advance given to you.

And that brings us to a common question in terms of how factoring and even other cash advance and unsecured loan products work.

Is accounts receivable an asset?

While you may have already known what accounts receivable was, you may not know the function of accounts receivable in many modern business financing products.

In financing products such as invoice factoring, your accounts receivable is treated as an asset.

In the same way that property or cash is put down as collateral with a traditional secured bank loan (the word secured itself referring to the fact that the loan’s repayment– in the case that you default– has been secured through some form of collateral), with factoring, part or all of your accounts receivable is used as both the method of repayment and a kind of soft collateral.

It’s an effective way for the lender to guarantee repayment of the funds they’re advancing for themselves without having to require any other form of collateral from you. It’s a win-win. 

This is why accounts receivable turnover is important in terms of financing products such as accounts receivable factoring.

Accounts receivable turnover refers to the number of times you collect your average accounts receivable balance in a given year, i.e. your average AR is $20,000 and you collect roughly $20,000 in payments from your AR 20 times per year, your turnover is 20.

A high accounts receivable turnover tells the lender that there’s a high likelihood they’ll be able to collect the advance. However, a lower turnover may lead to you not being approved (or being approved for less than you were hoping for).


How invoice factoring can help your business

Invoice factoring is a great low-risk option for small business owners who need funding to cover costs such as:

  • Payroll
  • Marketing
  • Rent
  • Vendor invoices
  • New equipment
  • Inventory and material purchases
  • and more

Many business owners are wary about taking on debt, especially when they already have open loans. Factoring is a great way to obtain the capital your business needs by using the invoices you already have in your possession as opposed to a small business loan.

Who invoice factoring is right for

Who is accounts receivable factoring best for? The types of businesses that can get the most use out of factoring include:

  • Construction
  • Logistics
  • IT and software development
  • Manufacturing
  • Staffing agencies
  • Freelancers
  • And virtually any other business that bills their clients using invoicing

However, keep in mind that any business that accepts invoices can take full advantage of accounts receivable factoring.

Any business that consistently finds itself facing cash flow issues due to unpaid invoices is most ideally suited for factoring their invoices.

You’ve got the accounts receivable, you just need a solution that allows you to tap into those invoices when you need the cash as opposed to when your customers are able to pay. That can put a huge strain on any business, especially those in manufacturing, construction, or anything similar which must use its own capital to purchase supplies to continue producing revenue.

It’s also important to consider the fact that having your invoices factored takes some control away from you as the business owner in terms of managing customer invoices. You need to be able and willing to do so for factoring to make sense.


Pros and cons of invoice factoring

So far, we’ve touched on the power of invoice factoring for those businesses which produce invoices upwards of $25,000 a month.

There are both several pros and cons to accounts receivable factoring, which we’ll summarize here to better help you decide if it is the ideal funding solution for you and your business.


1. The invoice factoring process is typically faster than obtaining a bank loan

Invoice factoring is one of the fastest sources of capital available to business owners and far faster than a traditional bank loan, with the entire process, from approval to funding taking no more than five to seven days on average (with approval within 24 hours in some cases).

Several types of fast business loans are also available to you which you can receive approval for and funding within two to four days. However, when compared to a traditional business loan, accounts receivable factoring is still quite fast.

2. It’s easier to qualify for invoice factoring than a traditional bank loan

Invoice factoring typically has no credit score requirement or the credit required is much lower than a traditional bank loan (in the “bad” to “okay” range), which means you can be approved for factoring with bad credit.

This is especially useful considering how much stricter banks are now when it comes to approving businesses for loans, particularly since the financial crisis of 2008.

3. Generate capital without taking on new debt

One of the most unique benefits of invoice factoring is something we touched on earlier: with accounts receivable factoring, you’re not taking out a loan, so you’re not taking on any debt.

A loan can be incredibly useful for a growing business or one which needs to consolidate its bills. However, if not managed correctly a loan can also get you into trouble.

By using the invoices you already have within your AR, you’re able to stay sustainable and keep your balance sheets even, using your internal resources for capital generation before extending beyond yourself with a loan.

4. It shortens the collection process

One of the clearest benefits of invoice factoring is that it allows you to essentially shorten the collection process with clients. This has the obvious benefit of getting paid sooner now but it also conditions your clients to pay you sooner because it lets them know that you mean business.

However, more than just that, while you give up some client control on the front end with factoring, being able to more quickly rid yourself of those open invoices can actually help you and your clients move on from those open bills they owe you more quickly, spending less time harping on what they owe you and more on how you can serve them.

5. You can improve your own accounts receivable management

No matter how long you use invoice factoring for, whether as a one-time tool for making bills or getting ready for a busy season or as a regular method for optimizing your cash flow collection, because you’ll have the chance to work with your factor’s accounts receivable team, you have the unique opportunity to learn from experts on how to optimize your own AR collection in the future.

This is especially useful if you don’t even have an AR department (or if you’re it). You’re then essentially paying for an AR team to help you collect without having to hire any additional full-time employees, which can be more than worth the small fees associated with accounts receivable factoring.


1. You give up some customer control

As we discussed a moment ago, invoice factoring may actually help improve customer relations. However, because factoring requires that you give up some customer control, there’s also the chance that may affect the relationship with your client whose invoice(s) are being factored.

This all depends on if the company is already familiar with how factoring works. If accounts receivable factoring is common in the industry or the company has experience with it, this isn’t likely to be a problem.

2. There are fees

The cost of factoring to you is mostly dependent upon whether the client pays on time or not.

Interest rates are higher with invoice factoring, however, that can be deceptive because invoices should only be open for one to three months, meaning even with a high interest rate the interest fee doesn’t amount to much.

However, factors typically charge a discount rate on a weekly or monthly basis, somewhere between .5% and 5% of the invoices total amount (typically lower the more invoices you have with the factor). This doesn’t tend to amount to more than a few hundred dollars on a $10,000 or more invoice, however, if the client doesn’t pay on time it can add up.

Make sure that the factor you go with is transparent with their fee structure and is willing to work with you to make things manageable.

3. There’s no guarantee the factor will be able to collect the invoice

While it’s rare that an active customer would leave an invoice unpaid, there is always the chance that the invoice which you choose to factor is never paid.

If your factor’s AR department can’t collect the invoice, you may be required to purchase the invoice back or, in more often cases, replace the original invoice with another of equal or greater value.

4. Invoice factoring depends on your client’s creditworthiness

While factoring doesn’t require you to have good credit, it does require that the client whose invoice(s) you want to factor has good credit.

If your client has a low credit score or some other mark on their credit which would deem them unworthy, you likely won’t be able to factor their invoices.


How to qualify for accounts receivable factoring

Compared to traditional bank loans, qualifying for accounts receivable factoring is relatively simple and straightforward.

A bank loan requires not only a stellar credit rating and clean credit history but solid financial numbers as well including revenue, profitability, and high debt-to-income ratio.

Most factors, on the other hand, only have three real requirements mostly having to do with the invoices you’re trying to factor themselves:

  1. The invoice(s) must be with business or government customers who have good credit scores and established businesses: Funding is dependent upon the creditworthiness of your business’ customers because the factor must reasonably know that they’ll be able to collect. Startups don’t qualify.
  2. The invoices must be unencumbered by other loans and due and payable within 90 days: Encumbrance refers to when an invoice which is placed as collateral at the same time as a loan is outstanding. The invoices must be unencumbered by other such debt-related responsibilities.
  3. No history of legal or tax issues: Your business should not have a history of any kind of serious tax-related or legal issues.

Applying for invoice factoring is quick and easy.

Complete our short application to see what you’re approved for within as little as 24 hours: Apply Now

What to consider before factoring

As we’ve discussed thus far, invoice factoring is a uniquely valuable source of small business financing. However, it highlights a common problem in small businesses: a lack of effective collection methods.

There’s a lot you can learn by working with a factor’s AR collection department. However, it’s also important to invest in maximizing your own collection efforts. If you’re still not able to get your cash flow up to where you’d like it to be, accounts receivable factoring can give you the edge you need.

The most important steps you can take to maximize your collection efforts are the most straightforward: using online accounting methods that make it easy to track what’s due, convenient payment systems that make it easy to receive payment, and even considering discounts for customers who consistently pay on time or early.

Best invoicing software

Perhaps the easiest step you can take to make your collection efforts easier and keep track of your business finances is to be sure you’re using a good invoicing software program.

There are a lot out there but some are designed with slightly different intentions. Some are leaner and more straightforward but could leave you wanting for certain functionality. Others are robust and while they might offer exactly what you need, they may also overwhelm if you’re looking for something simpler.

In general, you can’t go wrong with any of the below invoicing software, which we consider some of the best available:

1. Wave

Wave is particularly great if you’re on the smaller side as it simplifies the collection process considerably. Creating personalized invoices is a snap with their free invoice templates and Wave allows you to track the invoice’s progress until you’re paid.

It’s also great for streamlining payments, as it makes accepting most forms of digital payments very easy and it offers a tool which allows you to scan to accept payment directly.

Did we mention it’s completely free to use? This alone, when compared to its competitive functionality, makes Wave one of the best invoice software available.

2. Invoice ASAP

Invoice ASAP has one of the cleanest and easy-to-use mobile apps available when it comes to other invoicing software. This makes it especially well-suited for any professional who has to frequently hit the field and collect payments on the fly, something Invoice ASAP can do.

Where Invoice ASAP is also unique is in its ability to manage several team accounts simultaneously and track and manage their progress in real time, making it arguably the single best invoicing software for any business based around fieldwork.

3. Zoho Invoice

Zoho Invoice excels when it comes to helping developing businesses create, distribute, and manage invoices. If you don’t need all the other bells and whistles of much invoicing software, Zoho Invoice is one of the best software available for managing every stay of the payment and collection progress.

Zoho Invoice also offers two very unique options: time tracking and expense tracking. Both features give Zoho the unique ability to not just manage your books but your finances as a whole.


4. Freshbooks

Freshbooks is one of the more notable newer players in the invoicing software space.

It boasts one of the cleanest designs available and is great if you’re overwhelmed by Quickbooks or other invoicing software’s mountain of features and options and rather work with something simpler and more straightforward.


5. Quickbooks

The most well-known name in accounting software, Quickbooks has arguably been overtaken as the single best accounting software on the market, however, it remains one of the best without question.

Where Quickbooks excels is in its robust features (which, for some, may be more confusing than useful).

You can do virtually any accounting or business-related function you need with Quickbooks from managing your accounts receivable to creating and fulfilling purchase orders, customer shipments, tracking bills, and generating every report imaginable. Plus, QB’s list of integrations is longer than any invoicing software available.

No matter what invoicing software you choose to use, and what kind of system you follow, what’s important is simply that you work to optimize your collection efforts. This, in turn, will optimize your cash flow and reduce the number of occurrences where you’re strapped for cash.

What is the difference between invoice factoring and invoice financing?

One of the most common questions that comes up is: what is the difference between invoice factoring and invoice financing?

Both invoice financing, also known as accounts receivable financing, and factoring are highly similar, which makes it hard to differentiate between the two. However, there are a few defining differences.

With invoice or accounts receivable factoring, you sell the invoice to a factor who then pays you an advance (typically 85%) along with the rest once they’ve collected payment.

With accounts receivable financing,  or invoice financing, instead of selling said invoices they’re put up as collateral with the financier then advancing you up to 100% of the invoice amount. You then pay back the advance over a period of time (typically 12-24 weeks).

Here’s a chart comparing the difference between the two:

There are some distinct benefits to using invoice financing. The two most notable are:

  1. You can receive up to 100% of the invoice amount in advance: With factoring, you typically only get 85% advanced and the remaining 15% when the customer pays the invoice.
  2. You retain client control: The financier doesn’t have to communicate with your customer, allowing you to retain control.

However, it’s important to keep in mind that, like accounts receivable factoring, invoice financing has its own drawbacks as well.

With invoice financing, you’re not technically working from your own capital like you are with factoring. Invoice financing is a loan and you’re required to pay it back. Mismanage your revenue or take too long to collect and you could end up in a sticky position that would have been easy to avoid had you used factoring (or nothing at all).

Despite this, invoice financing is another useful financing option with several unique benefits, so it’s worth considering alongside accounts receivable factoring when you need to improve cash flow issues.

Frequently asked questions

We’ve detailed everything about invoice factoring above in a way that is simple and easy to understand.

However, as with any financing program, there’s a lot to it and you may still have questions that hasn’t been answered.

Below are some of the most frequently asked questions about accounts receivable factoring:

Do I have to factor all of my invoices?

No, but it ultimately depends on the factor and type of factoring used. Factors typically offer one or both of two options: spot factoring and contract factoring.

Spot factoring allows you to select one or more invoices to sell to said factor. It’s essentially a one-and-done deal.

In contrast, contract factoring is a kind of monthly agreement typically with a required volume of monthly invoices or some other requirement. This is an ongoing relationship where the factor will manage several of your invoices each month.

What fees do I have to pay when factoring an invoice?

Some factors charge certain fees in addition to the 0.5-5% discount rate fee we touched on earlier.

Ultimately, it depends on the factor whether they charge additional fees or not. However, here are some fees you might encounter:

Origination fees (multiple): Virtually every financing vehicle has some sort of upfront one-time fees associated with setting up the business relationship, accounts receivable factoring is no exception.
Lockbox fee: Some factors will charge a service or “lockbox” fee. Lockbox refers to a designated account for the customer to pay the particular invoice(s) to.
Collection fee: Some factors charge if the customer does not pay within the time frame designated in the invoice’s net terms (Net 30, 60, 90, etc.) and they must collect past due invoices.
Monthly minimum volume fee: This only applies for those who use contract factoring, particularly in the event that you cannot fulfill your part of the agreement to provide a certain number invoices.
Incremental fee: Your factor may charge an incremental fee in addition to the discount rate, which increases the discount percentage given to the factor as the invoice ages.

Remember to request information on any potential fees and review your contract before moving forward with a factor.

Does accounts receivable factoring require I give up customer control?

Factoring doesn’t require you to give up all customer control, however, it does typically require you give up some control as the factor must have the ability to contact the customer to collect the invoice(s).

However, a lot of new technology is being used to avoid any customer control issue. So you have to ask this question when considering accounts receivable factoring as a funding option

If this could pose a problem, or you’d simply prefer not to lose any level of customer control, accounts receivable financing, or invoice financing, is a comparable solution worth considering.

What happens if my customer doesn’t pay their invoices?

This depends entirely upon the contract agreement, so it’s important to talk to your factor so you know what the plan is in the unfortunate event that your customer doesn’t pay.

Is a good credit score required for accounts receivable factoring?

Typically, factoring your invoices has little to no credit score requirement. What the exact credit requirement is all depends on the factor.

Most Factors underwrite the creditworthiness of the company who owes you the invoice – not yours.

Some factoring companies have a 530 or higher credit score requirement (which falls within the “poor credit” range) while others have no credit requirement at all.

An ideal financing option for invoice-based small businesses

While there are many options for small business financing, invoice factoring offers a unique advantage that makes it ideal for many business owners.

If your business accepts invoices, especially larger invoices which require you to pay to manufacture product upfront that can put a strain on your business until you’re paid, factoring may be perfect for you.

Complete our short application to see if you qualify in as little as 24 hours: Apply Now