Is Invoice Factoring Right For Your Small Business?

invoice factoring small businesses

Invoice factoring — selling unpaid invoices to a factoring company in exchange for immediate cash — is a useful financing tool for certain businesses. If your business, like many others, has slow-paying customers that affect your cash flow, invoice factoring might help you manage your finances. But how, exactly, does invoice factoring work? And should your business use factoring services? Keep reading to find out!

Invoice Factoring Basics

Invoice factoring is essentially a sales transaction in which a business sells their unpaid invoices to a factoring company, at a discount, in exchange for immediate cash. Typically, the factoring company will hold a percentage of the invoice value in reserve; when the customer pays, the company will send you that money, less the factoring fee.

Factoring is generally used to solve cash flow problems caused by slow-paying customers. Instead of waiting 60, 90, or even 180 days for a customer to pay, the business can sell the invoice to a factoring company to get the cash needed to maintain business operations or take on new projects.

A factoring arrangement might look like this: You sell an invoice valued at $5,000 to a factoring company. The factoring company sends you $4,500 (90% of the invoice value) and keeps $500 on reserve. Your factoring fee is 0.06% per week. Your customer pays after 35 days, or 5 weeks, so your fee is $180 ($30 per week). The factor deducts their fee, and sends the remaining reserve, totaling $320, to you.

Invoice Factoring Eligibility

If you run a B2B business and you invoice your customers, chances are you’re a good candidate for invoice factoring.

Unlike with many other types of business financing, your business’s revenue and creditworthiness are not especially large considerations when determining eligibility; invoice factors are more concerned with the creditworthiness of your customers because your customers are the ones paying the bills. So, even if you own a young business without a financial track record, or you don’t make very much money, or you have poor personal credit, you might still be eligible for invoice factoring.

Is Invoice Factoring Right For My Business?

You may be eligible for invoice factoring, but should you use a factoring service? There are a lot of pros to factoring your invoices, but it’s not a perfect fit for all businesses. To determine whether factoring is right for your situation, ask yourself these questions:

Are my finances suffering due to slow-paying customers?

Slow-paying customers can affect many areas of your business. If you aren’t paid for your work until months after you have completed the job, you might have trouble meeting business expenses, purchasing inventory and supplies, paying employees, or paying for overhead costs. If this is the case, invoice factoring can be a simple way to ensure that you have the working capital you need.

However, invoice factoring is not always cheap, which is why you need to consider this next question:

Can I afford invoice factoring?

In general, factoring fees (called discount rates) range from about 1% – 6% of the invoice value per month, depending on the particulars of your factoring arrangement and how high-risk your client is. If you sell an invoice from a particularly slow-paying client, and you have a high factoring rate, you could wind up paying around 18% of the invoice value in fees for the opportunity to get your money sooner.

Many invoice factors also charge additional fees for factoring services. You might be charged money transfer fees, servicing fees, monthly minimums, or other expenses, which can add up over time. Head over to our explanation of factoring rates and fees to learn about discount rates and other commonly charged fees.

All that said, your fees will depend on a number of components, including the factoring company you are working with, the creditworthiness of your customers, the number and size of the invoices you want to sell, the industry your business is in, and other considerations. You will have to look at your options and decide whether the cost is worth it to your business.

Even if you decide that you need a financial solution, invoice factors most likely aren’t your only option.

Would an alternative financing solution work better?

Now, more than ever, businesses have a plethora of financial solutions available. While invoice factoring might seem like the perfect solution to your cash flow problems, the following might be a better fit:

  • Asset-Backed Lines Of Credit: These credit lines can be backed by unpaid invoices or (occasionally) assets like inventory or other receivables. The amount you are able to borrow depends on the value of your collateral. Asset-backed lines of credit work similarly to invoice factoring, but might offer more flexibility in some ways. These credit lines also tend to have lower rates than financing that isn’t backed by anything, so you might qualify for low rates and fees in comparison to other options.
  • Revolving Lines Of Credit: With a revolving line of credit, the amount you are able to borrow replenishes as you repay your debts. While some revolving lines of credit are backed by collateral, some simply require you to sign a personal guarantee and/or pledge general business assets via a blanket lien. With this type of financing, you’ll always have money available when you need it. And because you repay weekly or monthly, you don’t have to worry about getting fined because your customers forgot to pay their bills. Head over to our article on business lines of credit to learn more about this type of financing, or scan this list of our favorite lines of credit if you’re interested in learning about your options.
  • Business Credit Cards: Business credit cards can be useful if you need cash short-term for business expenses. You can put many purchases on credit cards and repay them on a timetable that works for you. However — especially if you tend to carry a balance — you might want to consider other options, because credit cards have notoriously high rates and fees. If you’re looking for a business credit card, check out some of our favorites.
  • Small Business Loans: If you only need funds one time, or if you need a large sum of money, a small business loan might be a good bet. Some lenders have long application processes, but many, including PayPal Working Capital and OnDeck, can let you know if you’re eligible within a very short time period. Most small business loans come in the form of installment loans or short-term loans. Small business loans can be used for a number of purposes, such as working capital, payroll, inventory purchasing, and other uses.

Final Thoughts

If you’ve decided that invoice factoring is a potential solution for your business, good for you! Invoice factoring can be a very viable way to maintain cash flow for your business, especially if you tend to get bogged down by slow-paying customers.

Interested in learning more? The following resources provide additional information about invoice factoring and may assist you to find the right factor for your business:

  • A Basic Introduction To Invoice Factoring: Invoice factoring basics, including what to look out for, a basic explanation of fees, and alternative services to factoring
  • Understanding Invoice Factoring Rates & Fees: An in-depth look at factoring rates and fees, including the variables that affect your rates, the three most common fee structures and their differences, and other fees you might have to look out for.
  • Spot Factoring vs. Invoice Factoring: A guide to help you determine whether your business should choose a spot factoring service, a high-volume factoring service, or some other alternative service.
  • Merchant Maverick’s comprehensive reviews of invoice factoring services provide honest and thorough assessments of some of the most popular invoice factoring services available.

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