What is Invoice Factoring for Small Businesses?

Making money as a small business involves a lot of money, from repairing equipment to paying invoices. However, you might not always have the cash flow to handle it all. Therefore, by converting outstanding client invoices into cash, invoice factoring, sometimes called accounts receivable factoring, enables small firms to swiftly obtain operating capital.

What Is Invoice Factoring?

Businesses can sell unpaid client invoices in their accounts receivable to independent invoice factoring companies. They use the financing technique known as invoice factoring. As a result, small businesses can acquire funds through invoice factoring to meet their short-term funding needs.

The invoice factoring company will send the business a portion of the invoice amount up front after purchasing unpaid invoices from the business. They then wait 30 to 90 days for your customers to pay them. The remaining balance is paid to the company by the factoring firm after they receive payment.

How Does Invoice Factoring Work?

By converting unpaid bills into cash, invoice factoring makes use of a small business’s outstanding invoices. This is how it works:

Consider a scenario where your small business requires $20,000 to replace some essential equipment but lacks the requisite working cash to do so. Instead of applying for a loan from a regular bank, you choose to look at your accounts receivable as a means to unlock the cash you need.

You discover, after doing some research, that you have $25,000 in outstanding invoices. You decide to sell your receivables to an invoice factoring business. The business promises to enter into an invoice factoring contract with you. This means that they promise to purchase your accounts receivable for the invoice value minus a 4% factoring charge.

If you accept the conditions, the invoice factoring company will pay you $24,000 in total for the bills open invoices. Within a few business days, these suppliers ordinarily start a cash advance for a part of the entire purchase. The average rate on cash advances is 85%. They send you the remaining money once the invoices have been fully paid.

Is invoice factoring a loan?

Not exactly. Although it’s not strictly a loan, invoice factoring does give you access to funds you don’t currently have. An invoice factoring business purchases a number of your invoices in exchange for cash instead of lending you money with the assumption that you will repay it. They will recoup their investment when they get payment from your clients within 30 to 90 days. As previously stated, when the customer pays, you will get the remaining amount of your invoice factoring contract.

When contrasting invoice factoring with conventional bank loans, there are a few more distinctions to be aware of. For instance, companies that factor invoices give your customer’s creditworthiness more consideration than yours. That’s because your consumers, not you, are in charge of paying back the debt. Due to the fact that invoice factoring is an unsecured form of financing, unlike a bank lender, an invoice factoring business does not require collateral.

Is a Loan Preferable to Invoice Factoring?

It varies. Make sure to consider your company’s goals, financial requirements, and the value of your outstanding bills when determining whether invoice factoring is the best option for you.

Trevyn Myers

Trevyn is a business journalist with a wealth of experience covering the world of finance and economics. With over a decade of experience reporting on the latest trends in the corporate world, Trevyn has a reputation for being a knowledgeable, insightful and analytical journalist. He has a keen eye for spotting emerging trends and is able to explain complex financial concepts in a clear and easy-to-understand manner.