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How to work with an invoice factoring company

Small Business
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Key Takeaways

  • Invoice factoring lets you collect money from unpaid invoices more quickly
  • You’ll typically pay a percentage of the invoiced amount for this service
  • It can be a quick way to get financing, but it could lead to cash flow issues if used regularly

If your small business needs funding, an invoice factoring company can help improve your cash flow. For a fee, these companies give cash advances for outstanding invoices and take over collecting the debt. 

This is a good option for small business owners who need cash fast and can’t qualify for traditional business loans. But not every business is eligible for this alternative lending option, and it has a few disadvantages, including costly fees. Read on to learn more about how to work with an invoice factoring company and see if it’s a good fit for your small business. 

What is invoice factoring

Invoice factoring is a way to get cash from unpaid invoices. An invoice factoring company buys your outstanding invoices and pays you a cash advance for the amount owed (anywhere from 70 percent to 90 percent of the full invoice amount). 

When the client is ready to pay the invoice, they make their payment to the invoice factoring company. The invoice factoring company then deducts its fees and pays you any remaining amount. 

For example, a small-business owner in need of financing submits an invoice for $10,000 to an invoice factoring company that has agreed to advance 80 percent of the value of an invoice. So, the owner receives $8,000. Once the invoice factoring company has received payment from the invoiced client, it will advance the remaining value of the invoice minus any fees.

Are you eligible for invoice factoring

Most businesses that use invoices are eligible for invoice factoring. It’s even open to businesses with bad credit. That’s because invoice factoring companies look at the creditworthiness of your clients paying the invoices to determine if they will work with you. 

Some of the types of businesses that commonly use invoice factoring include:

  • Transportation/trucking companies
  • Staffing agencies
  • Healthcare suppliers
  • Government contractors
  • Manufacturers
  • Service providers

To be eligible for invoice factoring, you need to meet a few requirements:

  • Have unpaid invoices. If you don’t invoice customers often, consider other financing options.
  • Have sufficient monthly sales. Most lenders want your business to have steady sales before you apply for factoring.
  • Have creditworthy clients. If your customers have bad credit, factoring companies will hesitate to lend you money as lenders use your clients’ credit, not yours.
  • Have a proper business established. You’ll need a business bank account, a tax ID number and business formation documents.
  • Have adequate profit margin. Factoring costs a percentage of your sales. If a factoring company charges 3 percent and your margins are only 2 percent, you aren’t likely to receive financing.

How to work with an invoice factoring company

Ready to start invoice factoring? Follow these steps to start working with a factoring company. 

Find the right factoring company for you

Invoice factoring companies aren’t all the same. They often differ in the types of factoring they offer, how quickly they send you funds and how funds are disbursed. Some companies also have a better reputation with customers than others. Check websites like the Better Business Bureau to see if other people had a good experience working with them before you make a decision. To help you choose, here’s a look at a few common options to consider when working with an invoice factoring company.

Recourse factoring vs. Non-recourse factoring
Most common option. Requires the business owner or operator to shoulder the responsibility of unpaid invoices. If a client doesn’t pay the invoice by the due date, the company must buy them back from the factoring company.  The factoring company assumes liability for unpaid invoices. If a client doesn’t pay an invoice, it does not affect how much the business gets from the invoice factoring company. Compared to recourse factoring, this option could come with lower advance rates and higher fees.
Notification factoring vs. Non-notification factoring
The invoice factoring company takes on the invoice and works directly with your client to collect payment, and the client knows you are working with a factoring company. Used in sensitive situations where businesses do not want clients to know they are using a factoring service. The factoring company interacts minimally with the client, and customers are not notified that you are working with an invoice factoring company.
Spot factoring vs. Whole-ledger factoring
Also known as single invoice factoring, spot factoring allows businesses to factor only one or a few invoices. They don’t have to factor every invoice.  The invoice factoring company takes over all of your outstanding invoices (or your whole ledger), and you must pay fees for all outstanding invoices. 

Understand the costs

Factoring companies may charge various fees to use their service. Be sure to read your invoice factoring agreement thoroughly to understand the fees as they can significantly increase the overall cost of the loan. Here are common fees to look out for:

  • Sign-up fees
  • Monthly minimum fee
  • Early termination fee
  • Late payment fees
  • Same-day funding fee
  • Wire transfer fee
  • Due diligence fee

In addition to administrative and sign-up fees, factoring companies usually charge a factoring fee or discount factor rate for advancing you the cash. The fee typically ranges from 1 percent to 5 percent, though the structure is different for each factoring company. The fee is usually taken out of the invoice amount as a percentage.

For example, if the factoring fee is 2 percent and the invoice amount is $10,000, the charge would be $200. 

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Some factoring fees are based on tiered rates.

For instance, the factoring company may charge a starting rate of 2 percent up to 30 days and an additional 1 percent for every 10 days the client takes to pay. If the client takes 50 days to pay their invoice, the factoring fee would be 4 percent of the invoiced amount. 

Apply for factoring

Once you’re ready to work with an invoice factoring company, gather the necessary documents and resources. Here’s what you may be asked to provide:

  • Credit-worthy clients: Invoice factoring requires your clients to have good credit (not you) to qualify for an invoice factoring service. 
  • Invoices to factor: You need outstanding invoices to use a factoring service. These are how you will get funding. 
  • Business Tax ID: Your Employer Identification Number identifies you as a business. This also allows the factoring company to look up your business and check for any outstanding liens, which could make you ineligible for invoice factoring. 
  • Business bank account: The factoring company will only work with clients who have a business bank account. This is where they deposit your funds. 
  • Personal identification document: You need to provide a document like your driver’s license, social security number or passport to verify your identity. 
  • Accounts receivable (A/R) aging report: This document shows any current invoices and how long they’ve gone unpaid. 
  • Completed factoring application: This will be different depending on the invoice factoring company you choose, but you can typically expect to provide basic business details, your typical monthly invoicing volume and your industry. 

Submit invoices

Once you’ve applied for your business loan and are approved, here’s what happens next: 

  1. Submit your invoices to the factoring company. 
  2. The factoring company pays you an advance rate for the submitted invoices (as agreed upon in your contract). 
  3. The client pays the invoiced amount to the factoring company. 
  4. The factoring company collects the agreed-upon factoring fee and any additional fees and pays you any remaining amount you are owed. 

Pros and cons of working with an invoice factoring company

Alternative lending options, like invoice factoring, have pros and cons that you need to consider before applying.

Pros

  • Quick funding. Once you sign up for a factoring service, many factoring companies will pay the advance for an invoice within a few days. 
  • Doesn’t require you to have good credit. Invoice factoring is dependent on the creditworthiness of the client, so it’s a good option if you need a business loan for bad credit
  • Better cash flow. Waiting for clients to pay invoices can interrupt important cash flow timelines for your business. Invoice factoring gives you a reliable cash flow timeline. 
  • Doesn’t require collateral. Some conventional business loans require you to secure a loan with an asset that the lender can claim if you fail to repay the loan.

Cons

  • Potential extra fees. Some invoice factoring companies have additional fees on top of the factoring fee. While the service can look affordable, the extra fees can add up, making the service more costly than it’s worth. 
  • Doesn’t work if clients have bad credit. If your clients don’t have good credit, the invoice factoring company won’t take on your invoices. 
  • You may have to pay back the factoring company. If you are using a recourse factoring service, you may be required to pay back advances for invoices that are never paid by a client. 

Bottom line

An invoice factoring company is worth considering if you’re a small-business owner who needs to overcome a cash shortfall. If your business qualifies, invoice factoring can quickly get you much-needed funds to keep your business up and running.

If you decide to work with an invoice factoring company, make sure you understand the risks and costs. Talk to several different companies and understand the terms of their service. Even the best small business loans can have surprises tucked away in the fine print. Make sure you know what you are responsible for when you sign on with a factoring company. 

Frequently asked questions

  • No. Invoice factoring companies use the creditworthiness of your clients to determine if they will work with you. So it’s more important that your clients have good credit. 
  • Invoice financing works more like a traditional loan. A lender will use the invoice as collateral and lend the business the money for an invoice. With invoice financing, the business still collects payment from the client and is responsible for paying back the loaned amount to the lender. On the other hand, invoice factoring means the business sells its invoices to a factoring company. The factoring company then pays a cash advance to the business and takes responsibility for collecting payment from the client. 
  • The amount charged by factoring companies varies. The average cost charged for a factoring fee is usually between 1 percent and 4 percent of the invoiced amount. 

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