What Is Factoring?
Invoice factoring helps businesses solve cash flow shortfalls by providing immediate cash for their unpaid invoices. More precisely, a factoring agreement is a contract between a provider of goods and services and a financial institution known as a factoring company. In this contract, the factoring company pays the provider a percentage of the face value of an invoice amount and then assumes responsibility for collecting the outstanding invoice amount owed for goods or services by the customer.
What is the Benefit of Using a Factoring Company?
Companies that bill other businesses for goods and services provided often wait weeks or months for the invoice to get paid. Creating better cash flow control processes can help, but it’s not always enough to overcome cash flow shortfalls, especially when unexpected events occur at the same time outstanding invoices are piling up.
Invoice factoring companies help bridge the gap by providing a short-term debt-free working capital solution by leveraging accounts receivables.
Factoring vs a Traditional Bank Loan
Invoice factoring is different from a traditional bank loan in lots of ways.
- Fast approval
- Fast funding (same-day available)
- Flexible limits (factor as much or as little as you like)
- Approval based on strength of business’ customers
- Small-business owners and startups qualify
Traditional Bank Loan
- Borrower pays back principal and interest
- Application process can take weeks or months
- Slow funding
- Hard limits set by the lender
- Approval based on applicant’s creditworthiness
- Only well-established companies qualify
Is accounts receivable financing the same as factoring?
Most people don’t differentiate between accounts receivable financing and factoring. Invoice discounting, invoice financing or receivable factoring often get lumped into the same group too.
However, the word “financing” references taking out a loan. Therefore, in true accounts receivable financing, you’re borrowing money and using your invoices as collateral. You’re responsible for collecting from your customers and you’ll pay back your loan with interest in instalments. Because you retain the balance sheet, it’s like any other type of loan—your customers will have no way of knowing you’re leveraging it unless you tell them.
When the term includes the word “factoring,” you’re not borrowing money or taking out a loan. You’re essentially selling your invoices to factoring providers at a discount rate. The factoring company is responsible for collecting from your customers and you have no debt to pay back. Customers are therefore aware when you’re working with a factoring company, but because it’s quite common and factoring companies often make it easier to pay, it’s usually seen as a positive thing.
Is accounts receivable financing or factoring considered debt?
Factoring is a debt-free solution because your customers are the ones who pay the balance, not you. However, a true financing arrangement does involve debt, so it’s important to confirm the terms before signing.
Invoice Factoring vs Invoice Discounting
Invoice discounting is similar to factoring, but the biggest difference is in who collects. Again, with factoring, your factoring company collects from your customers. With discounting, you’re responsible for getting the payments collected, but your customers make their payments into an account that’s managed by your discounting company.
Types of Factoring
Just as there are several ways to use your outstanding invoices to solve cash flow problems, there are several types of invoice factoring too.
Recourse & non-recourse factoring
The checks a factoring company performs on your customers prior to accepting an invoice for payment go a long way to ensuring the customer will make good on their obligation. Unfortunately, there is no way to guarantee a company will pay their invoice. With recourse factoring, you are ultimately responsible for paying the factoring company back any amount advanced to you if your customer doesn’t pay. With non-recourse factoring, you don’t have an obligation to pay the remaining balance if the customer doesn’t pay.
One of the major benefits of factoring is that a business can choose which invoices to factor and how often to factor. Some businesses factor frequently while others do so intermittently as needed. When both parties come together for a single financial transaction—to factor only one invoice—it’s referred to as spot factoring. This is more common when a small-business owner has most or all their revenue tied up in a single large invoice and requires immediate cash to continue operating.
Reverse factoring (supply chain finance)
Whereas traditional factoring is initiated by the “seller” (the provider of goods or services), reverse factoring, also known as supply chain financing, is initiated by the “buyer” (company ordering goods or services). In these cases, the buyer is typically a large enterprise in good financial standing that wants to wait to pay an invoice, but the seller is a midsize or small business that can’t afford to wait for payment.
Picture a chain auto repair shop in the United States that needs to order a special part for an exotic car and it’s only available from one overseas supplier. The repair shop doesn’t want to pay for the part until their customer pays for the work. Or, imagine a large retailer that’s setting up a pop-up shop and needs to pay a trucking company to move their displays across the country. The retailer may not want to pay the trucking company until their shop is generating revenue.
In situations like these, the buyer can approach a reverse factoring company and get approval for supply chain financing. However, like traditional factoring, it’s the seller that’s responsible for paying the fee. Most are happy to do so because the amount is largely based on the enterprise’s creditworthiness, so rates are quite low, and accepting the terms allows them to fulfil a large order without waiting for payment. This in mind, both the buyer and seller must agree to the terms set. When the service is complete or goods are transferred, the factoring company pays the seller. The buyer then pays the factoring company at a later date according to the terms set.
What is the Factoring Process?
Step 1: A customer places an order with your company.
Step 2: Your company verifies the credit of your customer with Viva Capital.
Step 3: Your company completes the order to the approved customer.
Step 4: You sell the approved invoices to Viva Capital and receive cash within 24 hours.
Step 5: Viva Capital’s accounts receivables experts handle the collection process for you.
Step 6: You keep track of your invoices 24/7 with our Accounts Receivable Reporting.
What Kind of Companies or Industries Use Factoring?
Virtually any B2B company that sends invoices for services or goods after they’ve been delivered work with factoring companies. A few of the most common industries are outlined below.
Shippers sometimes take up to 90 days to pay transportation companies for carrying a domestic load. International jobs can take even longer. In the meantime, the transportation company needs to pay for fuel, tires, payroll, and other expenses. Factoring solves these short-term cash flow problems, empowering the transportation company to accept more work.
Healthcare factoring typically falls into two main brackets: factoring for providers and factoring for vendors. On the provider side, it’s invoices due to paid by Medicare, Medicaid or private insurance companies that are processed. On the vendor side, it’s things like medical equipment, staffing, patient transportation, and other bills that are covered.
Viva Capital’s proximity to the Permian Basin has contributed to longstanding relationships with countless oilfield services companies. Although we serve a wide variety of niches, quite a few work in infrastructure construction, rig/site preparation, disposal, sand, water haulers and pipeline services.
All types of manufacturing companies, from textiles through oil and gas, chemical, food, electronics, and more, rely on invoice factoring from time to time. It’s a huge benefit to startups and small businesses that don’t qualify for bank loans but need working capital to cover labour and raw materials while waiting for payments as well as those trying to secure more business or scale-up.
Labour is the greatest expense for most industries, but it’s virtually everything to staffing companies. Unfortunately, it’s also one of the most inconsistent industries for cash flow as well. More often than not, staffing companies use factoring to cover payroll, but sometimes it helps companies scale, enhance their marketing, and cover other expenses.
Like staffing companies, businesses in the service industry often struggle with inconsistent cash flow and slow-paying clients, all while trying to manage payroll. Everyone from accountancies through pest control companies fall within this bracket, and all may qualify for factoring as long as they have unpaid B2B invoices.
What Fees Are Involved When Using Invoice Factoring Services?
It’s important to clarify that when you’re leveraging invoice factoring services, the advance rates will vary from one company to the next and even within the same company depending on the riskiness of the deal. For example, you may only get 50 percent of a spot factoring transaction up front. Lots of companies promote advances of 70 percent under ordinary circumstances too. On the other hand, Viva Capital will advance up to 100 percent of the value. In all cases, however, there’s usually a factoring fee involved as well.
That’s because, unlike loans, which come with interest payments, factoring companies typically charge a flat rate for their services. The amount generally ranges from one to five percent of the advance rate. The creditworthiness of your customers, your invoice volume, the level of risk, and specific terms of your factoring agreement will all weigh into the rate you’re quoted.
Suffice it to say, invoice factoring services are generally not less expensive than bank loans, but they do help businesses that don’t qualify for bank loans and are one of the few no-debt working capital solutions available for small-business owners.