How does Invoice Factoring work?

How does Invoice Factoring work?

Invoice factoring is a financing arrangement in which a business sells its outstanding invoices or accounts receivable to a third-party financing company, called a factor, in exchange for immediate cash.

Here’s how invoice factoring typically works:

1. The business provides goods or services to its customers and issues invoices with payment terms (such as net 30 or net 60).
2. Instead of waiting for the customers to pay the invoices, the business sells the invoices to a factoring company. The factoring company typically advances a percentage of the invoice value to the business (often 80% to 90%).
3. The factoring company then takes over the collection of payments from the customers. When the customers pay their invoices, the factoring company subtracts its fees and remits the balance to the business.
4. The factoring company may charge fees for its services, such as an application fee, a discount fee (the cost of the advance), and interest or other charges for any unpaid invoices.

There are two main types of invoice factoring: recourse and non-recourse. In a recourse factoring arrangement, the business remains responsible for any unpaid invoices and may have to buy them back from the factoring company if they are not paid within a specified time frame. In a non-recourse factoring arrangement, the factoring company assumes the risk of non-payment and absorbs the losses if the customer does not pay.

What Kind of Business is Invoice Factoring Good For?

Invoice factoring can be a good option for businesses that need to improve their cash flow or that have difficulty obtaining traditional financing due to limited credit history or collateral. However, it’s important to carefully evaluate the terms and fees of any factoring arrangement before signing a contract.