How to compare and work with invoice factoring companies

If your small business needs funding, invoice factoring can help improve your cash flow. For a fee, invoice factoring companies give cash advances for outstanding invoices and take over collecting the debt.

This is an alternative lending option for small business owners who need cash fast and can’t qualify for traditional business loans. But, not every small business is eligible for invoice factoring, and it has a few disadvantages, including costly fees.

How to work with an invoice factoring company

Ready to start invoice factoring? Follow these steps to start working with a factoring company.

How to find the right invoice factoring company for you

Invoice factoring companies often differ in the types of factoring they offer, how quickly they send you funds and how funds are disbursed. To help you choose, here’s a look at a few common areas to consider when working with an invoice factoring company.

• Check the requirements to apply. Invoice factoring companies generally want to see healthy cash flow in their business and may set minimum revenue guidelines. They will also look at your customers’ creditworthiness to see if they have a history of on-time payments as well as your business’s financial statements. Factoring companies may not be upfront about all their requirements, so contact customer service to ask questions.
• Understand which type of invoice factoring you’ll receive. Invoice factoring advances come with a variety of different features that you should be aware of. Features to watch for include:

• Ask about invoice factoring fees. Factoring companies usually charge a percentage of the invoice amount as its fee (explained below). Since different companies have different fee structures, you want to make sure you understand how fees get charged with the specific company you’re looking at.
• Consider the company’s customer service track record. Some companies also have a better reputation with customers than others. Check websites like the Better Business Bureau to see if other people had a good experience working with them before you make a decision.
• Check financing limits and funding speeds. Factoring companies may set a percentage limit on how much funding they will provide to you, called the advance rate. The advance rate is based on the amount of your invoices and typically falls between 70 and 90 percent of your total invoice amount. Most companies can also provide funds quickly, such as one to three business days, but some take longer.

Understand the costs

Factoring companies may charge various fees to use their service. Be sure to read your invoice factoring agreement thoroughly to understand the fees, as they can significantly increase the overall cost of the loan. Here are common fees to look out for:

• Sign-up fees
• Monthly minimum fee
• Early termination fee
• Late payment fees
• Same-day funding fee
• Wire transfer fee
• Due diligence fee

In addition to administrative and sign-up fees, factoring companies usually charge a factoring fee or discount rate for advancing you the cash. The fee typically ranges from 0.5 percent to 5 percent, though the structure is different for each factoring company. The fee is usually taken out of the invoice amount as a percentage.

For example, if the factoring fee is 2 percent and the invoice amount is $10,000, the charge would be $200. 

Apply for factoring

Once you’re ready to work with an invoice factoring company, gather the necessary documents and resources. Here’s what you may be asked to provide:

• Credit-worthy clients: Invoice factoring requires your clients to have good credit (not you) to qualify for an invoice factoring service. 
• Invoices to factor: You need outstanding invoices to use a factoring service. These are how you will get funding. 
• Business Tax ID: Your Employer Identification Number identifies you as a business. This also allows the factoring company to look up your business and check for any outstanding liens, which could make you ineligible for invoice factoring. 
• Business bank account: The factoring company will only work with clients who have a business bank account. This is where they deposit your funds. 
• Personal identification document: You need to provide a document like your driver’s license, social security number or passport to verify your identity. 
• Accounts receivable (A/R) aging report: This document shows any current invoices and how long they’ve gone unpaid. 
• Completed factoring application: This will be different depending on the invoice factoring company you choose, but you can typically expect to provide basic business details, your typical monthly invoicing volume and your industry. 

Submit invoices

Once you’ve applied for your business loan and are approved, here’s what happens next: 

1. Submit your invoices to the factoring company. 
2. The factoring company pays you an advance rate for the submitted invoices (as agreed upon in your contract). 
3. The client pays the invoiced amount to the factoring company. 
4. The factoring company collects the agreed-upon factoring fee and any additional fees and pays you any remaining amount you are owed. 

Pros and cons of working with an invoice factoring company

Alternative lending options, like invoice factoring, have pros and cons that you need to consider before applying.

Bottom line

An invoice factoring company is worth considering if you’re a small-business owner who needs to overcome a cash shortfall. If your business qualifies, invoice factoring can help you get fast funds to keep your business up and running.

If you decide to work with an invoice factoring company, make sure you understand the risks and costs. Talk to several different companies and understand the terms of their service. Even the best small business loans can have surprises tucked away in the fine print. Make sure you know what you are responsible for when you sign on with a factoring company. 

Frequently asked questions

• Do you need good credit for invoice factoring?

  No. Invoice factoring companies use the creditworthiness of your clients to determine if they will work with you. So it’s more important that your clients have good credit. 

• What is the difference between invoice financing and invoice factoring?

  Invoice financing works more like a traditional loan. A lender will use the invoice as collateral and lend the business the money for an invoice. With invoice financing, the business still collects payment from the client and is responsible for paying back the loaned amount to the lender. On the other hand, invoice factoring means the business sells its invoices to a factoring company. The factoring company then pays a cash advance to the business and takes responsibility for collecting payment from the client. 

• How much do factoring companies charge?

  The amount charged by factoring companies varies. The average cost charged for a factoring fee is usually between 0.5 percent and 5 percent of the invoiced amount.