Invoice Factoring: The Ultimate Guide for SMBs


How does invoice financing work? How does invoice factoring work?

There are two different ways to fund unpaid invoices: invoice factoring or financing. So how does factoring work? With factoring, invoices are sold to a factoring company in exchange for immediate payment (minus a small fee). Your customer pays the factoring company according to their payment terms. With invoice financing, the factory company still pays your invoice quickly. The key difference between invoice factoring and financing is in how the advance is repaid. Instead of your customer paying the factoring company, they pay you as usual. Then, you repay the invoice financing company over several weeks or months with agreed-upon instalments, such as monthly payments. Invoice financing is sometimes mistakenly referred to as an invoice factoring loan, factoring loan, invoice lending, factoring lending, or as invoice loans.

What is invoice factoring and how is it used? How do factoring companies work?

Invoice factoring is an accounts receivable financing option where a business sells unpaid invoices to a factoring company for quick payment ahead of net terms. The factoring company gives you an upfront cash advance (minus any factoring costs) and then collects the invoice from your client according to the original payment terms.

Invoice factoring for small business is a preferred financing method because it works by advancing money you’ve already earned. You don’t have to present a business plan, pass credit checks, or otherwise jump through hoops that have traditionally made it difficult for new and small businesses to get funded. By funding invoices with FundThrough, you can collect on your invoices immediately instead of waiting 30, 60, or 90 days for clients to pay. Get more info and context by reading this related post: What is invoice factoring and how does it work?

How do you factor an invoice?

Factoring your outstanding invoices is really quite simple, and takes just a few basic steps:

  • Create (or connect) your account. Create a free FundThrough account or sign up with the factoring company of your choice. 

  • Select which invoice(s) to fund. Upload or send invoices you want to fund to the factoring company. 

  • Factoring company does due diligence. The factoring company will verify that your business is legally established, and the submitted invoice(s) is legit.

  • Your customer is asked to sign an NOA. Signing the Notice of Assignment (NOA) means your customer understands that the factoring company now owns the invoice so they can redirect payment.

  • You get funded. On approval, your funds are deposited into your business bank account as soon as the next business day, upon approval, with many factors (short for “factoring company”).

  • Your customer pays the factoring company. When the invoice is due, your customer simply pays the factoring company, and the invoice factoring process is complete.

What's an invoice factoring example?

One of the most common reasons companies turn to the factoring industry is to make payroll. Let’s look at an example. 

Say you run a temporary staffing company. The people you place into jobs expect to be paid every two weeks. However, your clients only pay you 60 days after being invoiced. Such a funding gap can leave you in a bind if the opportunity to take on a big staffing project comes up. You need quick payment to overcome these cash flow challenges, but unfortunately your bank has already denied you a limit raise on your business line of credit.

You decide to use a factoring service to fund $250K worth of invoices on a regular schedule, getting your business capital in days for a cost of invoice factoring of $7,500 at a 3% discount rate per 30 days. You now have peace of mind about payroll, and you’re even able to take on a new relationship with a major company who opened a local office and regularly needs temporary workers.

Get a deeper breakdown and more invoice factoring examples.

Does invoice factoring solve for late payments?

Yes. When you fund an invoice, funds are deposited to your bank account typically within days. Not only does factoring solve for late invoice payments, it gets you paid ahead of net terms – in days instead of months. Factoring saves you the time on collections and administrative cost of chasing down late payment because the factoring company handles the collection for you. A good factoring business will treat your customers professionally and work with you first in the event of a late payment. See our approach.

Is invoice factoring bad?

Invoice factoring isn’t bad, but there has been stigma around the factoring industry in the past. Some invoice factoring companies would aggressively chase clients down to collect payment, damaging relationships. A few bad actors gave the entire factoring industry a bad name. Additionally, some business owners are afraid that funding invoices would make them look like they’re in financial trouble to their customers.

We can’t speak to all factoring companies, but at FundThrough we work with you first before contacting your customer about a late payment. And the opposite is true about struggling companies using invoice factoring: many of our clients fund invoices so they can get working capital to take big projects to grow their companies. Just see some of our client stories.

What is invoice verification for factoring?

Invoice verification is the process of ensuring that the invoices being factored are authentic. It’s a typical process for factoring companies to ask your customer to verify that the invoices are real and that they’ve accepted them. This is usually done through a simple email exchange.

Do customers like invoice factoring?

Many large companies are used to working with suppliers who use invoice factoring solutions, and have accounts payable departments who are familiar with redirecting payment to a traditional factoring company. In certain industries, like energy and staffing, it’s incredibly common. Many customers are okay with paying a factoring service because it keeps their suppliers well capitalized and it doesn’t cause them any inconvenience.

Factoring Use Cases

What percentage of companies use factoring?

Data on how many companies use factoring services is sparse, but according to Capstone’s 2020 Global Factoring Report, approximately 2.1% of North American businesses use factoring. This is likely just a small percentage of the companies that could benefit from it. 

Factoring is becoming an increasingly common source of next- or even same-day funding, especially in certain industries like staffing, oil and gas, and for growing businesses in general. At FundThrough, we see B2B businesses in all types of industries use invoice factoring to improve their access to cash. 

Can small businesses use invoice factoring?

Yes.Small business invoice factoring makes sense for a number of reasons: to raise working capital, improve cash flow, expand your product or service offerings, purchase equipment, increase the size or quality of your workforce, buy out a partner, and more. Factoring also allows businesses to take on growth opportunities and bridge any cash flow gaps such as covering everyday expenses like payroll. As an added bonus, invoice factoring is easier to qualify for than bank financing, and is faster and easier to get started.

Can startup companies use invoice factoring?

Yes. Like small business factoring, invoice factoring for startups is unique in that business owners are not required to jump through the income verification and credit history hoops traditional banks require for loan and credit card or LOC applications. Not only that, banks won’t often work with new businesses, anyways. They require you to have several years of income statements and financials to show a strong track record to be considered for traditional forms of business financing, which startups often don’t have.

Can you factor government invoices?

Yes. Factoring isn’t limited to business factoring. You can factor many types of invoices, including invoices from government entities. Government contract factoring allows you to get an advance on your unpaid local or federal government receivables for growth, payroll, and more so you can skip time-consuming bank financing.

What is freight invoice factoring?

Freight factoring is a common way for trucking companies and independent truckers to manage their cash flow. Learn more about transportation factoring.

What are the different types of factoring?

There are a couple of different types of invoice factoring. The first is based on how you use factoring as a financing tool:

1. Whole turnover: You sell your invoices to a third-party that advances you a percentage (typically 70-80%) and pays you the rest, minus their service charge, when they collect from your client.

2. Selective: You have an ongoing relationship with the third-party factoring company that allows you to choose which invoices to fund and when.

3. Spot factoring: You need to access funds from an invoice factor infrequently but as quickly as possible to cover a cash flow emergency.

The second way invoice factoring is classified refers to the structure of your invoice factoring arrangement with the factoring company: factoring with recourse, factoring without recourse, maturity factoring. Let’s take a look at each of these in detail.

What is factoring with recourse?

With recourse factoring, you are responsible for paying back the advance to the factoring company if your customer doesn’t pay the invoice.

What is non-recourse invoice factoring?

When you work with a non-recourse factor, the liability of an unpaid invoice transfers to the factoring company, so you are not responsible for unpaid invoices. Non-recourse factoring is typically more expensive than recourse factoring.

What is maturity factoring?

With maturity factoring, you do not receive an advance on the amount invoiced. The factoring company pays out the invoiced amount (less their financing fee) on the invoice due date, or some other date (the maturity date) you’ve agreed upon in advance.

What is invoice discounting?

Invoice discounting means that your invoices are used as collateral for a short-term loan. Invoice discounting companies advance a percentage of the value of your invoice(s). You continue to handle collections from your customer. Once your customer pays you, you can repay the advance, including any interest and fees. It is similar to invoice factoring, except you continue to manage collections, and your customer does not know you’re working with a finance provider.

What is disclosed factoring?

When a third-party purchases your invoices and begins debt collection, your clients receive communications from that party. The relationship is then disclosed; it’s evident that you’ve used a factoring company, as they are either collecting on your behalf or are now the owner of the debt and collecting on their own behalf. The factor’s name may even be indicated on your invoices. The opposite of disclosed factoring is undisclosed factoring or non-notification factoring, and it’s when your customer is unaware of a factoring service’s involvement with your business.

What is cross-border factoring?

Cross-border factoring is a type of invoice factoring for international transactions. An example would be a Canadian company factoring an invoice for a U.S. company. Online invoice factoring makes it possible for you to choose the best, most flexible invoice funding solution for your business’s unique needs, regardless of geography.

What type of invoice factoring does FundThrough do?

Our AI-backed technology has enabled us to offer clients the best of all worlds:

  • Cross-border factoring. Companies in both the U.S. and Canada can use FundThrough. Setting up an account takes just a couple of minutes and once you’re approved, requesting funding is easy.
  • Selective factoring. With selective factoring, FundThrough lets you pick and choose which customers and which invoices you want to fund. There’s no monthly minimum requirements or number of invoices you have to fund each month.
  • Online factoring. Our platform enables you to request streamlined invoice funding on invoices in one click after the initial account setup.

Why Use Invoice Factoring?

As factoring has evolved to become more affordable and mainstream, more and more companies are using it to increase liquid capital. A few common factoring use cases are taking on growth projects, covering payroll, purchasing equipment, and hiring staff. Companies also use factoring because it is quick, easy, and flexible — especially compared to traditional bank financing, which often has lengthy and cumbersome application processes. New companies also benefit from this funding option because their lack of business history and credit history don’t qualify them for bank financing.

Is factoring a good idea?

Factoring is a good idea if you need working capital quickly, are a new business, and have credit worthy customers. Compared to the costs, complexity, rejection rate, and risks of financing solutions like bank loans and venture capitalism, and the relatively low success rate of crowdfunding, factoring can offer a simple, straightforward solution to funding your business using money you’ve already earned.

Is invoice factoring worth it? How much does factoring cost?

Invoice factoring is often worth it for businesses who would face big problems or lose out on opportunities without access to quick working capital. Today, innovative technology and our straightforward price structure make invoice funding a smart funding solution for new and small businesses in all sectors. At the end of the day, business owners have to weigh the various aspects of factoring for their unique situations.

Is invoice factoring risky?

Factoring itself is not inherently risky. Any risk has to do with your customer not paying their invoice — but that risk is present when taking on the deal, whether you factor the invoice or not. A good factoring company will communicate early and often with you when your customer is at risk of not paying, and work with you to find a solution.

What are the advantages to factoring?

Factoring empowers you to put money you’ve already earned to work in your business right away. The biggest benefits of invoice factoring are that you have flexible working capital to invest in your business however you see fit — purchasing new inventory and equipment, taking on new or larger contracts, or simply covering your day to day expenses with less stress. It also puts you in control of when invoices get paid, and you don’t have to spend precious time and energy chasing down customer payments. You also don’t have to deal with annoying bank hassles or time-consuming paperwork. 

What are some invoice factoring pros and cons?

Some of the benefits of invoice factoring include:

  • Improved cash flow. With flexible invoice funding anytime you need it, you can rest easy knowing you have cash on hand to make payroll, pay your suppliers, and meet other financial obligations. As an added bonus, invoice factoring is not a loan so you aren’t adding debt to your balance sheet!
  • Less bank hassles. Invoice factoring is much easier to qualify for than traditional bank financing, without having to jump through the hoops of traditional lenders. It’s also easier to qualify — even if you have bad credit or no credit.
  • Non-dilutive funding. With factoring, you’re not giving away equity in your business, keeping you in control of your company.  
  • Unlimited capital. Because invoice factoring is a revenue-based financing solution, the more you invoice the more liquid capital you can access. Unlike some other factoring companies, FundThrough doesn’t have a limit to the amount of flexible invoice funding you can access. 
  • Fast turnaround. Many factor companies can deposit funding in days to your bank account. Bank loans, credit card, and lines of credit applications can take weeks or even months! Applying for grants is also a time-consuming and drawn-out process. Factoring gets you paid in days. 
  • Reduced admin load. Since the factor works with your customer to settle the outstanding invoice, factoring actually saves you time on collections as you no longer have to chase accounts receivable.

Invoice factoring has some perceived negatives, including:

  • Customer contact. Because factoring requires your customer to redirect payment to the factoring company, some customer contact is involved for initial account setup and invoice verification. Any good factor will treat your customer like their own (it’s what we do at FundThrough) to maintain the relationship.
  • Bookkeeping. While it’s true that there is a bit of a learning curve when it comes to accounting for factoring transactions in your bookkeeping software, our step-by-step guide helps demystify the process — even if you don’t use QuickBooks accounting software, as is referenced in the guide. 

What are the qualifications for invoice factoring?

All factor companies all have different qualifications for invoice factoring. Some qualifications include your customers being credit worthy by having a certain credit score, that you’re a business selling to other businesses, that any factored invoices are not older than a few months. See if you qualify for invoice factoring with FundThrough.

Invoice factoring vs invoice financing: Is there a difference?

Yes! With invoice financing, your invoices for completed work are advanced and you pay back the balance yourself. You are still responsible for collecting payment from your customers. Factoring, on the other hand, means that you sell your invoices to a factoring company who advances a percentage of the funds and collects payment from your client. Get a deeper breakdown on the difference between invoice financing vs factoring.

Yes, there’s is a difference between invoice factoring and invoice trading. Invoice trading is when companies sell their invoices through an online lending platform. Investors purchase these unpaid invoices, and the selling company receives a percentage of funds as an advance. It is a type of peer-to-peer lending solution. It allows the company selling the invoice to get fast access to upfront cash, but these factored invoices often don’t come at a favorable advance rate (the amount you’re advanced up front).

Invoice factoring vs discounting: Which is better?

Invoice discounting is a funding option where your invoices are used as collateral for a short-term loan. Invoice discounting companies typically advance around 80% of the value of the invoice, and charge an interest rate above prime (plus a monthly fee) to maintain the loan, for as long as its takes to repay. With invoice factoring, you can get up to 100% advance rates (minus any factoring fees) and the factoring company handles collections on your behalf. Which one is better will depend on your individual situation and funding needs.

Factoring vs bank loans: Which is better?

Bank loans typically require a lengthy application and approval process – valuable time that a small business often doesn’t have. Additionally, most new and small businesses often lack the business credit rating, collateral assets, or other prerequisites business banks require when evaluating loan applications. As a result, many new or small businesses get rejected. Even businesses with a established lines of credit can get rejected for a raise on their LOC limit.

That said, a line of credit can be a useful form of financing if you can get it: because you can draw on it any time and they typically come with low rates, they are flexible and affordable. You can find out how bank financing and invoice factoring can work together in Should I get an Line of Credit for My Business?

When you factor an invoice, you get quick access to working capital, plus the flexibility to get funded whenever. On top of that, factoring comes with an easier application process and qualification than traditional business financing options. FundThrough in particular makes this process easy thanks to our innovative AI technology and integration with popular invoicing software such as QuickBooks.

Factoring vs overdraft: Which is better?

Both business loans and overdraft are forms of financing. With factoring, you’re getting an advance on revenue you’ve already earned. With overdraft, you’re overdrawing your bank account to a set limit.

With factoring, you don’t have to worry about paying back the working capital – you can simply put your money to work, however you see fit. Overdraft is debt that comes with interest payments or financing charges that can quickly add up if you aren’t careful.

Invoice factoring requires customer notification, whereas overdraft does not. You can access unlimited funds with factoring (at least with FundThrough), while overdraft will have a limit. 

We think factoring is preferable to a business loan or overdraft because it allows you to unlock liquid capital without creating new debt, but there may be situations where overdraft is the better choice for your business. Like many choices in business, it will likely depend on the situation. 

Invoice Factoring FAQs

What is a factoring company?

A factoring company is a business that quickly advances you funds that you’ve already earned, based on your outstanding invoices. It then waits on your customer to pay the invoice according to net terms, which can be months long. This means you get quick payment in a few business days instead of months. These businesses can also be referred to as “factors” for short.

Do factoring companies need to be local?

While some business owners feel more comfortable with a local company, a receivable factoring company doesn’t have to be local to pay your invoices quickly. With online factoring, you can get invoices funded across North America.

Why do factoring companies or banks finance only 80-85% of an invoice?

Some people ask, “Do banks factor invoices?” and the answer is no. Many factoring companies only offer 80-85% of an individual invoice as an advance rate – meaning they pay you that percentage of your original invoice now and they hold the other 15-20% as collateral. Then, they pay you the rest of your invoice once your customer pays them, less the factoring fee.

How long does it take to factor invoices?

It depends on the factoring company’s approach and your customer’s responsiveness. In some traditional factoring companies with manual processes it will be slower than with a technology-based factoring company that has automated processes. However, your customer has to verify the invoices and agree to redirect payment. If they don’t respond to communications quickly, that slows the process down no matter what kind of company you work with. In short, it can take days to weeks.

Is invoice factoring fast?

It is as long as your customer redirects payment and verifies the invoices quickly. It’s even faster with a factoring company that’s backed by technology.

How much does a factoring company charge for their services?

Different invoice factoring companies will charge different factor rates for their services, however, the average discount rate is typically somewhere between 1%- 6%. A lot of factors go into determining invoice factoring rates. Don’t just think about the discount rate either! Some companies require a long-term contract that requires you to fund all your invoices for customer or requires you to fund a minimum dollar amount every month. Many factoring companies often charge hidden fees like termination fees or transaction fees. To tell you about our approach, FundThrough’s pricing structure is completely transparent — no hidden fees, no monthly minimums, no need to factor every invoice from your customer. No matter which factoring company you decide to work with, be sure to read your invoice factoring agreement fully before committing. 

Who are the best invoice factoring companies?

The best factoring company gives you access to quick, convenient funding in days when you need it, with a transparent fee structure that’s easy to understand. The same is true for the best invoice financing companies. See our post on the best invoice factoring companies for more.

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