The Factoring Option - Learn How Invoice Factoring Works

Invoice factoring is quickly becoming a mainstream business financing tool that being used by small, medium and large sized businesses. It has been gaining traction in part because banks have tightened their lending standards, leading company managers to look for business financing elsewhere.

Although most business owners are familiar with how business loans work , few are familiar with factoring. The most important thing to know about factoring is that it is designed to help companies that cannot afford to wait 30 to 60 days to get paid for their invoices. Companies that sell products to other companies or the government usually need to wait 30 to 60 days to get their invoices paid. While some companies have no problem extending 30 days terms, many do and can't wait. Invoice factoring solves this problem by giving your company an advance for the invoice. This minimizes the amount of time you wait to get paid and provides funds to cover business expenses.

When you factor an invoice, your company actually sells the financial rights to the invoice to the factoring company. Because of this, the transaction is structured as a sale, with two payments from the factoring company. The first payment, usually referred to as the advance, is given to your company as soon as you sell the invoice. The advance is about 80 to 90% of the invoice. You get the remaining payment of 10% to 20% (less factoring fees) once your client actually pays the invoice. This second payment is usually referred to as the rebate.

One major difference between a business loan and a factoring line is that qualifying for factoring is a lot easier and quicker. Since factoring companies are usually buying the invoices they factor, their biggest concern is the credit worthiness of the company paying the invoices. Because of this, small businesses and distressed companies can usually have a good chance of getting a factoring line, provided they work with a strong roster of customers.

Costs for factoring will vary but are usually higher than the cost of a business loan. Costs are determined by the size of the line, the credit quality of the invoices, the industry and the stability of the client's business.