5 Min. Read

What Is Factoring in Invoice & How Does It Work?

March 15, 2024

Sometimes a business needs an inflow of cash quickly. However, that fast flow of cash isn’t always possible. When that happens, the business might feel doomed. Expenses don’t pause because your cash flow has. If your business is experiencing a cash stall, have no fear. Some of your outstanding invoices can save you. Learn about factoring services for unpaid invoices here!

Here’s What We’ll Cover:

What Is Invoice Factoring?

How Does Factoring Work?

The Benefits of Factoring

The Negative Aspects of Factoring

Key Takeaways

What Is Invoice Factoring?

Invoice factoring is a type of invoice finance. The process consists of selling some or all of your outstanding invoices to a factoring company. A factoring company is a third party service that will pay for your unpaid invoices. They don’t pay the full amount for the invoices, however. They pay a portion of the outstanding debts and then directly collect from your customers.

By selling the accounts that have outstanding payments on them, your business is able to improve cash flow. It also promotes revenue stability. Revenue stability is important in business because it allows you to pay for business expenses in a timely manner.

Invoice factoring goes by a few different names. It is also referred to as accounts receivable factoring or accounts receivables financing. Because of the nature of the accounts being sold, it is also known as debt factoring or debt financing. Unpaid accounts are more likely to turn into bad debts, and this is a way of getting rid of them in advance.

How Does Factoring Work?

Factoring works by selling accounts receivable. As a refresher, accounts receivable are any accounts that you’re expecting a payment on. When factoring, you can sell accounts fully, or in parts. Assignment of accounts depends on the invoice factoring services you are working with. The general timeline for accounts receivable factoring is listed below.

1. Provide Goods or Services to Your Customers

This part happens normally. You’ll provide the goods or services from your business, and the accounts will have an outstanding payment on them. They become part of your accounts receivable.

2. Customers Are Invoiced

Following services or goods being rendered, you’ll invoice your customers like you normally would.

3. Invoices Are Sold to a Factoring Company

After initial invoices have been sent to customers, the raised invoices can be sold to a factoring company. The company will pay you the bulk of the invoiced amounts immediately. This amounts to approximately 80 to 90 per cent of the worth of the accounts.

4. Factoring Companies Collect the Payments

Rather than you collecting payment, the factoring company will collect from your customers. Invoice companies will pursue customers for payment should they need to. However, they are not debt collection agencies. Factoring companies only collect current debt. Collection agencies collect bad debts.

5. The Factoring Company Pays You the Remaining Invoice Amount

After payments have been collected in full, the factoring company will pay you the remaining 10 to 20 per cent of the invoice. The full invoice amount will not be received, though. Factoring fees will be subtracted from the invoiced amounts.

The Benefits of Factoring

There are a number of different benefits to be gained from invoice factoring. The most notable advantages of factoring are listed below.

Invoice factoring improves cash flow forecasting – Factoring ensures payment. By knowing that you’ll be paid for outstanding invoices, your business can better predict cash flow and how to use it.
It allows businesses to survive – Ups and downs in the market can be perilous for businesses. By selling accounts to a factoring company, businesses can obtain amounts of cash they may not bring in otherwise.
It is easier than a bank loan – Invoice factoring is easier and cheaper than a loan. Bank loans require interest and applications. Invoice factoring is more like striking a deal.

The Negative Aspects of Factoring

Factoring can have a negative impact on your business, as well. Some of the biggest issues regarding factoring are listed below.

Factoring requires a large amount of accounts – Factoring companies deal in bulk. They want most, or all, of your accounts receivable.
Can be an unexpected expense – Factoring isn’t always an upfront expense. If your clients don’t pay the factoring company, you may be paying additional fees.
Can create a negative relationship with customers – Customers want to pay you. They didn’t sign up for services to deal with a third party. This can damage relationships and trust.

Key Takeaways

Factoring is an excellent way for a business to generate cash fast. Selling accounts receivable to a company to collect on them means less work for the business. It also means not collecting the full amount, though. Sometimes, factoring can’t be avoided though. If you want more business insight, be sure to check out our resource hub!