Guide to Invoice Factoring

By Georgia Galloway | Wednesday 6th December 2023 | 5 minute read

Invoice factoring is a financial strategy that can help businesses quickly access cash tied up in unpaid invoices. It involves 'selling' control of your accounts receivable, either partially or fully, to an invoice factor company.

A man and a woman sat at a business desk reviewing spreadsheets and a tablet with an invoice displayed

When you raise invoices for goods or services provided, instead of waiting for customers to pay within their usual payment terms, which could take 30-90 days, you hand over these outstanding invoices to a factoring company. This process helps improve cash flow by immediately getting around 80-90% of the invoiced amount from the invoice factor.

Role of Factoring Companies

A key player in invoice finance is the factoring company itself. They essentially buy your raised invoices at a discount rate known as the' factor rate'. Once they've purchased your accounts receivable - it's then their responsibility not only to chase payments but also to handle credit control.

However, this role doesn't come without risks; if a customer pays late or defaults entirely on an invoice under recourse factoring agreement conditions, you must fix this debt with them. Most companies offer non-recourse options where they absorb any bad debts themselves.

When is Invoice Factoring Beneficial?

If your business faces cash flow issues due to a stack of outstanding invoices, invoice factoring might be just the financial solution you need. It's an effective alternative to bank loans for small businesses looking to bridge short-term expenses without adding more debt.

The advantage here lies in transforming unpaid customer bills into immediate capital. You're essentially selling these pending invoices to a factoring company, which then chases up the customers and takes responsibility for their payment. This process can significantly improve your cash flow while relieving you from the stress of chasing payments yourself.

Catering to Industry-Specific Needs

Invoice factoring can benefit most industries, particularly in sectors where extended payment terms are common practice - construction, manufacturing, or wholesale trade. Long waits between raising an invoice and getting paid are usual pain points that stifle growth and operation.

A poor credit history won't necessarily bar you from this financing method since approval depends on your customers' ability to pay rather than yours. However, remember that high-risk clients could inflate factoring costs due to additional fees imposed by some providers for risk management.

Small Businesses Growth

Entrepreneurs often struggle with securing traditional finance primarily because they lack substantial trading histories or assets for security purposes. 

Invoice financing also presents an opportunity if resources are tied up elsewhere within the business. With invoice factoring, you can leverage the sales ledger and get those invoices paid quicker to help fuel further growth.

Advantages and Disadvantages of Invoice Factoring

When considering invoice factoring as a financial solution, weighing the advantages against potential risks is essential. 

Unpacking the Benefits of Invoice Factoring

The key attraction for many businesses is predictable cash flow. By selling your invoices to a factoring company, you get an immediate advance on your funds—usually around 80-90% of their value. This lets you avoid lengthy payment terms that can tie up resources and disrupt operations.

Beyond improving cash flow, there are more benefits. A significant one is reduced overheads; outsourcing credit control staff tasks like chasing payments becomes the responsibility of the factoring company instead. The result? More time focusing on growth activities rather than admin duties.

Understanding the Risks of Invoice Factoring

While enticing, invoice factoring isn't without its downsides. One main concern revolves around credit risk associated with customers who have poor credit history or fail to pay outstanding invoices within agreed payment terms - this could lead to higher costs known as recourse factoring, where these unpaid debts come back.

In addition, small businesses may find invoice financing unsuitable if they don't have enough clients or raised invoices because this method relies heavily on having numerous accounts receivable available for sale.

Another downside involved with invoice factoring is the risk of the invoice factoring company delaying the finance. Should the finance be delayed, this unexpected setback could result in a time-critical situation where alternative financing is required, such as an emergency, urgent bridging loan to resolve the cash-flow issue.

Step-by-Step Guide to Invoice Factoring Process

The journey of invoice factoring begins with an initial assessment. Here, the factoring company looks at your business, mainly focusing on your accounts receivable and credit history.

They'll offer you an approval agreement if you're seen as low-risk. This typically includes details about the factor rate and other associated costs, such as additional fees for services like chasing payments or taking over credit control duties.

Funding Advance Rates & Payment Terms

Upon signing this agreement, you can start submitting invoices to them. They'll verify these before paying out up to 80-90% of their value immediately.

Your customers won't know anything's changed but will pay directly into the factoring company's bank account rather than yours when settling their outstanding invoices. Once they've received full payment from your customer, they give you back most of what's left after deducting their fee.

Taking Responsibility for Credit Control Staff

In some instances, known as recourse factoring arrangements, if any customers fail to pay within agreed terms due to insolvency or dispute reasons that aren't covered by non-recourse agreements. You may need to repay advanced funds or swap in another invoice instead.

This process helps improve cash flows and reduces time spent chasing payments so that small businesses can focus more on growth strategies than unpaid bills.

Comparing Invoice Factoring with Other Financing Options

Unlike bank loans, invoice factoring doesn't require extensive credit history checks. Instead, the focus is on the quality of your customers' payment abilities. This can make approval quicker than with conventional methods.

In terms of cost, spot factoring may seem more expensive upfront compared to full invoice factoring due to higher factor rates per transaction. However, it doesn't involve long-term contracts or minimum volume commitments like full-service options so it can prove cheaper over time.

Factoring vs Bank Loans

The significant difference between invoice factoring and getting a bank loan is accessibility and speed. Banks often require solid credit ratings and collateral before lending money- conditions businesses struggle to meet.

Banks typically take longer to process applications, which isn't ideal when dealing with pressing financial issues. On the contrary, an advantage of invoice factoring is that funding can typically be secured within 24 hours once set up.

Factored Invoices vs. Traditional Business Finance

While invoicing factors provide quick access to capital without adding debt (like in traditional business finance), this convenience comes at a cost. Factoring costs include a discount fee, which can be higher than the interest rate on a traditional business loan.

However, it might be worth considering when comparing this with the potential loss from being unable to expand due to a lack of funds or late payments.

We're experienced financial experts who arrange short-term bridging loans for property owners, securing you the best deal from over 200 bridging loan providers, including private investors and family offices.

If you experience any unexpected setbacks with delayed finance should your invoice factoring company delay finance and you face a time-critical situation, an urgent bridging loan can help.

Get expert assistance today; we're on hand to answer any questions about bridging loans.

Get a quote

Call our friendly team on 01202 612934, we're ready to help.

We use cookies. By using the website you agree with our use of cookies. For more information, please read our privacy policy.

Okay, got it!