A Guide to Invoice Factoring, Financing & Alternatives

Factoring financing, also referred to as invoice factoring is a financing process where a business sells its invoices to a company. In exchange for a portion of the balance on the invoice, the factoring/finance company pays the business the rest of the amount owing on the invoice. For businesses who are struggling with cash flow (or just don’t want to wait to get paid for an invoice), this type of transaction can be very helpful.

Another term for invoice factoring is accounts receivable factoring. All businesses that use factoring are B2B businesses, and most do so because they need financing options. Since it’s common (and often expected) to offer customers time to pay for their orders (called net terms), these transactions almost always include delays in payment to the business.

It doesn’t matter what size your business is. You can qualify for invoice factoring based on the credit of your customer. When you receive the funds from the factoring company, you can use them for any purpose. Most businesses use the money for overhead: staffing, rent, supplies, and transportation charges.

The standard timeline for finance or factoring

The first step in the invoice factoring finance process is always the sale. You (as the business) sell goods or services to another company and give them an invoice with the net terms listed. This means that the business is expected to pay the invoice within the terms listed—usually between 30 and 90 days.

When it’s your first time factoring an invoice from this customer, your next step is to set up a factoring account. During this process, the factoring company will check the customer’s history and credit to determine how much of the invoice they’re willing to factor. The better your customer’s history and credit, the more of the invoice the factoring company will cover.

If you like the terms the factoring company is offering, you can then proceed to sell the invoice to them. The company will pay you the agreed-upon amount—usually within a few days, but it can take up to a week or two.

When your customer pays the invoice, the money goes to the factoring company’s account (not your business account). After this happens, the factoring company will take their fee and send you the remainder of the invoice.

Small business owner working with laptop.

Is factoring just for small business?

B2B companies of all sizes use invoice factoring. They might be start-ups or long-established businesses. Sometimes they use factoring finance for just one or two customers, others may factor all their invoices. It generally depends on their financial situation and the capabilities of their accounting department.

The most common industries that use factoring including transportation, construction, manufacturing, and staffing. However, any business can use factoring if they issue invoices for products or services.

Some of the most common reasons for factoring relate to cash flow. Your business may have a temporary cash flow challenge because of unexpected expenses or unexpected delays in payment. You may need working capital but have been turned down by your bank for a business loan because of a lack of creditworthiness. Or your business may be too new to qualify for traditional bank business financing. Other business owners use factoring because it allows them to keep debts off their ledger.

Another reason to use factoring is to create capital for expansion. This allows a business to expand and take advantage of opportunities—even with substantial outstanding invoices. It’s a solution that addresses problems like poor credit history, prior bankruptcy, and lack of collateral.

There are four key areas where you must qualify in order to receive invoice factoring. The first is selling products/services to other businesses (B2B) or governments. B2C and retail companies don’t qualify. The second is that you’re offering net terms of 30 to 90 days to your customers. You need to have at least $50,000 in annual revenue. And, your customers need to be approved as creditworthy.

Note: If one customer is not approved for invoice factoring, you can still get factoring for other customers. Each case is evaluated independently. However, having a customer denied for factoring may indicate that they are more likely to be a credit risk, and you're advised to conduct your own due diligence before extending net terms. Factoring companies tend to prefer that businesses factor multiple customers and multiple invoices. Getting just a single invoice factored (called spot factoring) is possible, but will cost you more in premiums/factoring fees and factoring costs.

The advantages of invoice factoring

One of the most obvious benefits of factoring is prompt cash flow. Invoice factoring can also help companies offer net terms without worrying about a delay in getting paid. This is especially helpful for things like government contracts that require net terms.

It’s also good for businesses that don’t qualify for other funding options or can’t provide collateral or personal guarantees. And, for companies that don’t have a full accounts receivable department, it can reduce the accounting demands regardless of the invoice amount while providing nearly immediate cash for the business.

Manufacturers are just one of the industries that commonly use invoice factoring as a form of financing to cover the cost of raw materials that require payment upfront, and other urgent expenses.

The disadvantages of the invoice finance approach

The biggest concern for most businesses is the way the factoring company acts as an intermediary between them and their customers. Not all factoring companies have the same policies. Some conduct aggressive credit checks, and/or pursue unpaid invoices in ways that don’t reflect well on the business. Since business-customer relations are so crucial, this can be a huge deterrent. It can—and does—harm business relationships.

Invoice factoring and receiving factoring finance is tedious, requiring a new application process for each invoice. You may also be on the hook for customer non-payment (we'll look at this in more detail). Depending on the factoring agreement, most businesses will still be liable if the invoice goes unpaid.

And, while it’s generally easier to get approval than traditional financing, it’s also more expensive. Factoring companies are notorious for creating complex fee structures. You need to look out for servicing fees, termination fees, money transfer fees, renewal fees, and even monthly minimums. Finally, invoice factoring is a single method that addresses only one part of any overall business. It doesn't address needs like credit management, net terms solutions, or increasing your average orders.

What are the alternatives to invoice factoring?

Until a few years ago, the most common alternative to invoice factoring/factoring finance was a bank loan that covered any cash flow shortfalls for a business. But for many businesses, bank loans remained inaccessible.

However, recent changes have transformed the opportunities available for B2Bs through digital net terms. Resolve is a B2B payments solution that helps manufacturers, wholesalers, and distributers manage your net terms and improve your cash flow.

We provide discreet credit checks in minutes, and net terms approval in hours. This allows you to offer the best net terms to your customers, without the risks and intrusion of invoice factoring. We pay up to 90% of each invoice into your bank account within one day—and you're always in control of which invoices and customers.

But that’s not all! We believe your business shouldn’t act like a financial institution unless you’re actually a financial institution. So, we offer net terms, credit management, and accounts receivable automation. However your customers buy from you—ecommerce or online—we’ve got you covered. And when it’s time to pay their invoice, they can easily do so through an online portal that reflects your business.

Whether you don’t want to go through the lengthy process of applying for a bank loan, you’ve already been declined for financing, you need a reliable method of supply chain finance, or you’re just looking for a streamlined, professional way of handling your accounts receivable while receiving payments promptly, we’re here to help.

Is there a difference: Invoice financing or factoring?

Good question! Some people use the terms invoice factoring and invoice financing interchangeably, but there are some important differences. Factoring is always a sale of an invoice at a discount. You receive partial payment of the invoice quickly, but that invoice is no longer yours—it belongs to the factoring company.

Invoice financing (also known as receivable financing) is a loan using the receivables on the invoice as collateral. So, you still own the invoice and you’re responsible for collecting the entirety of the invoice.

With invoice financing, you’re adding debt to your balance sheet. You’re also using your own company’s credit history/credit score, possibly your personal credit score, and collateral in the form of the items sold. The one thing you don’t need is a creditworthy customer—because there’s collateral.

Most banks offer receivable financing, but you may also find an online lender to work with. Unfortunately, online lenders offering invoice financing are both accessible and risky. Even if your customers never pay their invoice, you still have to pay your lender. The interest costs may end up being prohibitive.

Man looking at unpaid invoices

What is recourse vs. non-recourse factoring?

The difference between recourse and non-recourse factoring boils down to risk: who takes the risk of an unpaid invoice.

With recourse factoring, you will have to pay the factoring company if the customer doesn’t pay. So, your business (and often you as the business owner) carry all the risk.

Some factoring finance companies offer non-recourse factoring which means that you’re not liable if the customer doesn’t pay. (It’s also called ‘without recourse’ factoring.) But there are three caveats: First, it involves a much higher fee/premium which may make the cost of factoring too expensive. Second, you will likely need to purchase credit insurance to cover the risk of non-payment. Third, factoring companies that do offer the non-recourse option only do so for your customers that have an excellent credit history and credit score.

While invoice factoring finance is certainly one type of financing for meeting your cash flow needs, it's useful to investigate all options to determine the one that best meets your business’s unique needs without creating unnecessary challe

Net terms & credit management

Ready to offer smarter credit with Resolve?