Invoice factoring is a form of business finance where a company sells its unpaid customer invoices to a factoring provider in return for faster access to cash.
Instead of waiting 30, 60 or 90 days for customers to pay, the business receives an advance against the invoice value. The factoring company then collects payment from the customer and releases the remaining balance, less its fees.
Invoice factoring is commonly used by business to business companies that issue invoices on credit terms and need working capital before customers settle their bills. It is part of the wider invoice finance market, which also includes invoice discounting. The British Business Bank describes invoice finance as a way for businesses to access money tied up in unpaid invoices and support cash flow.
The process usually works like this:
Many providers advance a large proportion of the invoice value upfront, often within a short period once the facility is active. The British Business Bank notes that invoice finance can provide funds within 24 hours of new invoices being generated once the arrangement is in place.
There are usually three parties:
This is different from a standard bank loan because the funding is linked to unpaid invoices rather than being based only on the borrower’s balance sheet.
Invoice factoring and invoice discounting are often confused, but they are not the same.
With invoice factoring, the factoring company usually takes control of collections and deals directly with the customer.
With invoice discounting, the business usually keeps control of its own sales ledger and customer payment process.
This means factoring is often more visible to customers, while invoice discounting can be more discreet. Allianz Trade describes invoice finance as covering both factoring and invoice discounting, with different options depending on how much control a business wants over collections.
Businesses use invoice factoring because profitable companies can still run short of cash when customers pay slowly.
Factoring can help with:
UK Finance states that invoice finance and asset based lending are used to unlock working capital and support businesses through the economic cycle.
With recourse factoring, the business remains responsible if the customer does not pay. This is usually cheaper but carries more risk for the business.
With non recourse factoring, the factoring provider takes on more of the bad debt risk, although this protection normally comes with conditions and exclusions.
Invoice factoring costs vary depending on:
Common charges can include a service fee, discount charge, arrangement fee, audit fee and additional administration fees. Read more about invoice finance costs here.
The exact cost should always be compared against the cash flow benefit, the time saved on credit control and the cost of alternative finance.
Invoice factoring is not always described as a traditional loan because the finance is based on selling or assigning unpaid invoices. However, from a practical business cash flow perspective, it still functions as a funding facility.
The important point is that repayment is linked to customer invoice payments.
Invoice factoring may suit companies that:
It may be less suitable for companies with mostly consumer sales, disputed invoices, poor debtor quality or very low invoice volumes.
Businesses may also consider:
The right option depends on cash flow need, cost, control, customer relationships and how quickly funding is required. Working with experienced commercial finance brokers can help clarify these choices.
A business issues a £10,000 invoice with 60 day payment terms.
The factoring company advances 85 percent of the invoice value.
The business receives £8,500 upfront.
The customer later pays the full £10,000 to the factoring company.
The factoring company deducts its fees and releases the remaining balance to the business.
This gives the business cash sooner, but the final amount received is lower than waiting for the customer to pay directly.
Factoring is a finance arrangement where a business releases cash from unpaid invoices by selling or assigning them to a third party provider.
Invoice factoring is one type of invoice finance. Invoice discounting is another.
It can if collections are handled poorly. A good provider should deal with customers professionally and protect the business relationship.
No. Many growing companies use factoring because growth can create cash pressure when customers pay slowly.
Yes, provided they sell to other businesses, issue invoices on credit terms and have suitable debtor quality.
It can be more expensive than some traditional lending, but the value depends on speed, flexibility, cash flow improvement and the cost of not having working capital available.
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