Invoice Factoring: What is it and what are the best options?
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Important to Know
What is Invoice Factoring?
Invoice factoring, also referred to as debt factoring, is the process of selling unpaid invoices to a lending institution that will then collect the overdue payments themselves. Invoice finance options are very effective at freeing-up capital that’s tied up due to non-paying (or slow-paying) customers. For business owners across a wide variety of industries, the issue of having clients who are slow to pay or refuse to pay altogether is all too real.
For example, if you own a trucking business and you have unpaid invoices piling up, you may want to consider freight factoring as one option to rev up your cash flow.
Naturally, the type of business as well as the specific circumstances that business finds itself in will affect the kind of industry loans a business needs. Be sure to weigh your options carefully in order to choose the right funding solution for your business.
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How It Works
More About Invoice Factoring
Why Do Businesses Use Invoice Factoring?
Research published in Entrepreneur points toward some eye-opening consequences of customers not paying invoices on time. We’ll allow the statistics to answer the question of why business owners opt for debt factoring:
- 79% of small business owners unable to pay themselves
- 23% of business owners unable to hire new employees
- 23% of business owners unable to purchase new equipment
- 20% of business owners stopping marketing campaigns
- 18% of business owners unable to give employees raises or bonuses
- 17% of business owners unable to stock up inventory
You now know what invoice factoring is, as well as what causes small business owners to use invoice factoring. But you’re likely also wondering how invoice factoring works.
How Does Invoice Factoring Work?
Debt factoring allows a business to essentially sell its unpaid invoices to a third party lender. The lender will typically provide 80% of the value of those invoices up front, followed by the remaining 20% upon collecting all of the payments. What’s in it for the invoice finance provider? In exchange for its services, the lending institution will keep roughly 1-4% of the total unpaid invoices.
One important point to keep in mind is that invoice factoring is generally used as a short-term quick fix for a business that is facing a cash flow slowdown. Ultimately, business owners will want to resolve the root cause, namely non-paying customers. Developing effective strategies for dealing with unpaid invoices is crucial to the long-term health of a business that faces this issue regularly.
How is Invoice Factoring Different from a Bank Loan?
Both invoice factoring and a ‘traditional’ bank loan will provide a lump sum of funds to the borrowing business owner, but the similarities pretty much end there. Aside from that, the two forms of business financing are quite different. How?
Invoice factoring does not incur debt the way that a bank loan does. Instead, business owners who choose invoice factoring sell their unpaid invoices to a lender at a small discount (1-4%).
Invoice factoring has a quick approval process whereby borrowing business owners only need to wait a few days to receive funds. Banks can take weeks or even months to give a response and provide the money.
Invoice factoring is virtually an unlimited source of business funding, assuming that customers and invoices are continuously being generated. To put it plainly, as long as your business has invoices, you’ll have the ability to use invoice factoring. Traditional bank loans have much stricter terms and conditions when it comes to qualifying for, and renewing, business loans.
There are many ways that alternative business funding has traditional bank loans beat when it comes to making financing available to small business owners. Be sure to stay up-to-date with all of the ways that financial technology is revolutionizing the business lending process.
Invoice Factoring vs. Invoice Financing: What’s the Difference?
Much of the time, the terms ‘invoice factoring’ and ‘invoice financing’ are used interchangeably as if they mean the same thing. While there are commonalities between the two types of invoice funding, they have their differences. It’s important that any business owner considering invoice funding solutions spends a bit of time clearing up exactly what those differences are.
The key distinction between invoice factoring and invoice financing (also called invoice discounting) is in regards to who actually goes about collecting the payments due. With invoice factoring, the lender that purchased the accounts receivable is responsible for collecting from customers. Invoice discounting, on the other hand, leaves the responsibility of collecting on the part of the borrower. That’s the main difference, but the terms and fees also differ.
Invoice factoring will typically provide 85% to 90% of the invoice value up front, while invoice financing is usually around 80%. Likewise, with the difference in the level of risk taken by the lender comes a difference in the fees. Invoice factoring usually has higher fees at around 2% to 4.5% monthly, while invoice financing is normally lower at roughly 1% to 3% per month.
Ultimately, the decision between invoice factoring and invoice discounting will largely depend on several factors including how reliable your clients are when it comes to paying their invoices, how much time you would have available to invest in chasing down those clients, how much of a percentage you’re willing to forfeit in exchange for the loan, and so on. Don’t rush your decision - weigh your options diligently, and take those different factors into consideration.
Best Invoice Factoring Companies for Small Businesses
Invoice finance solutions for small businesses are abundant, but how can you know which loan providers are the best? Take a glance at these top 3 lenders available through Become who offer invoice factoring and invoice financing for business owners in need of a boost to their cash flow.
Top 3 invoice factoring/invoice financing companies for small businesses:
Loan amount: Up to $100,000
Loan term: Up to 3 or 6 months
Loan amount: Up to $5,000,000
Loan term: Up to 12 months
Loan amount: Up to $250,000
Loan term: Starting at 24 months
(it won't impact your credit score!)
How to Qualify for Invoice Factoring
The qualifying criteria for invoice factoring or invoice financing will depend on the loan provider that provides the invoice funding. Generally speaking, qualifying for either invoice factoring or invoice financing is easier than qualifying for other types of business loans. The reason for that is that the lender is more concerned about the reliability of a business’s customers to pay their invoices, as opposed to the borrower’s ability to repay the loan.
That said, here’s a glance on some of the qualifying criteria for invoice factoring and invoice financing with the loan providers mentioned above:
Minimum time in business: 3 months
Minimum credit score: None
Minimum time in business: 6 months
Minimum credit score: 530 (FICO)
Minimum time in business: 3 months
Minimum credit score: 500 (FICO)
How to Apply for Invoice Factoring
Step-by-step guide for applying for invoice factoring or invoice financing:
- Choose your desired loan amount and select ‘Get Loan Offer’
- Fill in the requested information (including time in the industry, revenue, business, etc.)
- Submit your business’s checking account information for analysis
- Wait for offers. You can also review your status by clicking ‘Access Your Loan Application’
- Review offers and select your preferred lender
- Receive the funds to your business checking account
- Review your tailored LendingScore™ dashboard to improve your funding options
- Improve your rates - if your LendingScore™ is insufficient, follow the personalized plan (8-12 weeks to unlock funding)
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