What is invoice factoring?

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Invoice factoring—also known as accounts receivable financing—is a type of business financing that allows a business to accelerate cash flow by selling their invoices to a factor. The factor will advance the cash as soon as the business issues an invoice so that they don’t have to wait 30 days or longer to receive the funds.

Key facts about invoice factoring:

  • B2B businesses of all sizes and types use factoring, from startups to global enterprises.
  • Factoring is one of the most affordable sources of alternative financing.
  • Factoring does not negatively impact a business’s credit score, and in fact, can positively impact it.

The facts about factoring

Invoice factoring has existed for decades as a reliable, cost-effective means of increasing business cash flow, yet many businesses are unfamiliar with this financing option. This blog post looks at the basic facts about factoring to help businesses understand the benefits and decide whether to include it in their overall liquidity strategy. 

What types of businesses use factoring?

Businesses of all sizes and types use invoice factoring, from small businesses to global enterprises. Most of these businesses operate B2B and offer their customers terms of 30 days or more, which results in a wide gap between earning and receiving cash. These businesses may also have high up-front costs, such as a staffing company or transportation company that needs to pay workers weekly or even daily, or a manufacturing company that needs to purchase expensive inventory weeks or even months in advance. 

These situations can also indicate that invoice factoring could be a good fit for the business.

  • The business is growing rapidly and needs to finance delivery of a large contract or opportunity.
  • The business does not qualify for a traditional bank loan because:
    • Its credit rating doesn’t meet the bank’s requirements.
    • It doesn’t own assets that can be used as collateral.
    • It already has significant debt on the balance sheet.
  • The business already has traditional bank loans but can’t qualify for more.
  • The business wants to take advantage of vendor discounts for on-time or early payment.
  • The business prefers not to deal with loan administration and paperwork.
  • The business is a startup that can’t show two years of business history.
  • The business is seasonal or cyclical, resulting in an inconsistent cash flow.

How do businesses qualify for factoring?

Instead of looking at a business’s credit history and debt-to-asset ratios, a factor looks at these criteria:

  • The quality of the business’s accounts receivable. 
  • The credit-worthiness of the business’s customers.
  • The business’s potential for continued growth. 

How many invoices can a business factor at one time?

A factor will review the business’s accounts receivable and determine how many invoices qualify for factoring. 

Some factors lock businesses into long-term contracts that require the business to factor all qualified invoices, while others are more flexible. AR Funding, for example, gives businesses the option to factor as many or as few of their invoices as they would like. This type of flexible, open-term contract enables you to factor as many or as few invoices as you need, which means factoring can be used as a long-term strategy for improving business cash flow or as a short-term bridging solution.  

How much cash will the business see? 

A business will see as much as 95% of the value of their outstanding invoices immediately, with the remainder being remitted to the business once the invoices have been paid. Approval for factoring can take as little as 24 hours, after which the business receives the cash immediately.

How does factoring compare to other types of financing?

While factoring is generally more expensive than traditional bank loans and lines of credit, it is much more affordable than other types of alternative financing, such as merchant cash advances (MCAs) and online loans. While online loans carry interest rates as high as 80% and MCAs can climb as high as 350%, invoice factoring fees can range as low as 1% for 30 days, with no additional financing charges.

Learn more about how factoring compares to bank loans, online loans, and MCAs

Does factoring negatively impact a business’s credit score?

No, factoring does not harm a business’s credit score in any way. In fact, invoice factoring can improve a business’s overall creditworthiness by improving financial liquidity and resilience. SomeMany AR Funding clients, such as this industrial electronics firm, actually use factoring to demonstrate the level of liquidity and stability required for M&A or to qualify for a traditional loan.

Can factoring be used alongside traditional financing? 

Yes, factoring and traditional bank loans are often used together as part of an overall liquidity strategy. Factors often work closely with bank managers to ensure their customers have access to a full range of beneficial financial products. Learn more about this process: Read How Banks and Factors Work Together to Support B2B Companies

Learn more about factoring

For more information about factoring, read Top 10 Myths About Accounts Receivable Financing, or contact a factoring specialist at AR Funding.

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