Invoice Factoring for Small Businesses
Making sense of invoice factoring and how Swift SBF is different.
How does invoice factoring work?
Every invoice factoring service operates a little differently. You may have heard of invoice factoring or invoice discounting, but with both you access funds from an unpaid invoice. With invoice factoring, you sell your unpaid invoices to the factoring company and they collect payment directly from your customers. You also likely will receive 60-95% of the invoice value, not the entire amount.
How is Swift SBF different than invoice factoring?
The main difference between Swift SBF and invoice factoring is in the interaction with your customers. With Swift SBF you continue to work with your customers directly. You also get the full value of the invoice deposited into your bank account right away. Use Swift SBF when you need it most and continue to run your business and maintain client relationships as you always have.
What is the advantage of Swift SBF over other alternative business funding options?
For starters, Swift SBF is very easy to use. You can register in seconds without any paperwork or personal credit check to get started. Choose to connect your accounting software and bank account or just your bank account by itself, and we'll give you a credit decision in hours. If you're approved and advance an invoice, funds arrive in your bank account as soon as the next business day.
Introduction to Invoice Factoring
If you own a small business and have slow-paying customers or occasionally limited cash flow, you’ve probably considered or heard about invoice factoring. In this guide, we’ll explain everything you need to know about invoice factoring, from how it works to how to qualify, how much it costs, as well as factoring companies and alternatives to consider for your business financing.
Small business can use Invoice Factoring as an alternative to loans
Small businesses can use factoring as an alternative to loans. Instead of working with banks or lenders, small business owners can work with a third party called a factoring company (also simply known as a “factor”) to access funds by “factoring” outstanding invoices. Invoice factoring is a financing plan specifically designed for businesses that issue invoices with net terms, usually between 30 to 90 days. With invoice factoring, businesses can sell their unpaid invoices to get access to extra funding quickly.
Don't sell your invoices
Instead of offering a term loan, which is a lump sum, factors essentially “buy” invoices from your business. When you decide to “factor” an invoice, you are selling the unpaid invoice to the factoring company and they send you a fraction of the total invoice value. This means you receive a percentage of the invoice amount owed and the factoring company takes the rest as their fee for advancing and collecting the funds. The factor then collects on the unpaid invoices you sold them. The factor only sends you a fraction of the invoice value up front because they are taking on risk by factoring your invoices—they still must collect from your customer.
After the completion of this invoice “sale,” the responsibility for collecting the payment from your customer shifts from you, to the factor. The factoring company will contact the client who owes the invoice, and that client will need to direct payments and questions to the factor instead of you. This is an important feature of invoice factoring that you should consider, since it necessarily affects your relationship with your customer.
Why Invoice Factoring Matters
In short, invoice factoring matters because it is a financial tool that helps businesses get paid faster for work they have already delivered.
If you find that cash flow gaps due to slow customer payments are restricting the growth or operation of your business, you might think that the solution would be to simply ask your clients to pay their invoices sooner. If only it were that simple.
Invoice Factoring Lets You Offer Better Payment Terms To Win More Business
More often than not, most small- to medium-sized businesses (SMBs) are not in the position to offer shorter term invoices for a number of reasons. For example, some customers are used to those longer payment terms (aka "trade terms"), and taking away those terms may cause customers to take their business elsewhere. In some cases, shorter terms aren’t an option for your clients because they have expenses of their own and are simply unable to pay earlier. In some industries, offering a longer payback period is part of a larger negotiation strategy for getting the best deals. These are just a few of the reasons why many small businesses holding outstanding invoices turn to invoice factoring as a strategy for reducing their cash flow gap.
Invoice Factoring Popularity Among Business Owners
Invoice factoring has become popular among SMBs in recent years, since they are frequently in need of faster cash flow, not only to sustain their operations, but grow as well. If your business is still young, it might not be feasible to wait around for payments to come through before expanding operations to take advantage of new market opportunities. It’s also typical for smaller, earlier-stage companies to encounter unexpected expenses and events that drive costs over budget.
Invoice factoring can give you a chance to save valuable time and jump on unexpected opportunities that require cash in hand, fast.
How Invoice Factoring Is Being Used To Improve Cash Flow
Here are some examples of how business owners can make use of improved cash flow from invoice factoring:
“Making Payroll in Slower Times”
“Staffing and Hiring New Employees”
“Investing in Marketing & Advertising”
“Paying Rent and Reoccurring Bills”
“Collecting Funds Faster For Unpaid Invoices”
“Buying More Inventory To Increase Margin”
“Buying Materials For Projects”
“Buying New Equipment”
Historically, invoice factoring as a form of speeding up cash flow has existed for hundreds of years.
Quick history of Invoice Factoring for Small Businesses
Examples of factoring have been found as early as the ancient Roman Empire. In the early 1300s & 1400s, traders lent money against the delivery of trade goods. Merchants would trade this contract instead of the actual goods. Factoring has definitely been a part of doing business throughout the history of the United States. In the 1600s & 1700s when English colonists traveled across the sea to America, London would advance funds to purchase goods. While in the 1910s, the booming garment industry relied on invoice factoring to purchase raw materials to manufacture textiles.
Today, Internet access and technological developments have made factoring increasingly easy and accessible for small businesses. A recent development that came out of invoice factoring is invoice financing, also known as accounts receivable financing, which will be described in more detail below. As you begin to learn about invoicing factoring, you will see that it’s often compared to invoice financing, as they are both similar ways to get funding based on outstanding invoices. Many businesses have made invoice financing and factoring common practice.
Industries where invoice factoring and financing are common include:
Recruiting
Manufacturing
Construction
Printing
Courier services
Wholesale
Retail
Construction
Trade Services (like contractors, handyman, remodeling, landscaping, cleaning and more)
Professional Services (like marketing agencies, creative designers, accountants, and more)
Retail
Popular among small businesses, invoice factoring and financing are options worth considering for all types of businesses, regardless of industry. These type of financing plans work well for some growing businesses because they help make you unlock the funds you currently have sitting in unpaid, high-value invoices. If your business is struggling, this type of financing can also serve as a crucial lifeline by lowering your days sales outstanding (DSO) metrics, meaning you get your payments faster.
In this guide, you will gain a clear understanding of how invoice factoring and invoice financing works, so that you can evaluate and choose an appropriate identify which financing plan and company works best for your business.
Step 1: Finding a Factor
The first step of invoicing factoring begins when you send an invoice to your customer, asking them to pay for the goods or services you provided. Your bill would have a deadline for payment as well as instructions on how they can pay you back. You can find a factor and sell your invoice to them as soon as you’ve sent the invoice and your customer has agreed to pay.
Keep in mind that with invoicing factoring, you can only sell invoices that are payable within 90 days. If the payment term is any longer that that, your invoice may not be eligible for invoice factoring. When choosing whether to factor invoices, consider that the entire invoice factoring process can easily take a week, between the time you begin factoring to when you get your funds from the factor.
In addition to conventional factoring arrangements, there are so-called “spot factoring” arrangements (which we will discuss more in the comparison section of this guide). In short, these are transactions where a factoring company buys a single invoice from you, instead of a bunch at once, or many invoices on a predetermined schedule.
Spot factoring has some clear benefits, due to the greater flexibility you get when determining which invoices to sell. However, it’s harder to find this kind of arrangement. It’s also more expensive, with generally higher fees, and a high minimum amount. In fact, most spot factoring companies require that the invoice be several thousand dollars. The reason for this is that it’s more risky for the factor, since it’s much harder to predict the likelihood that individual invoices will eventually be paid. Since the risk is greater, the factor requires a larger reward to factoring your invoice.
Step 2: The Factor Agreement
Once you have selected a factoring company that fits your needs and budget, they will review your business credit and transaction history, as well as the invoices you are factoring. They may ask you for a series of personal documents, as well as perform a personal credit check on you or your customers. The goal of this evaluation is to discover the reliability of your customers and the likelihood that they will pay the invoices on time.
After this review, if you are approved, you will sign a factoring agreement and begin the factoring process. The factoring agreement should outline any fees, details of the payment plan, and the initial maximum dollar amount that will be given to you. That amount would be the maximum factored amount outstanding at any time. It is important to read all terms and documents carefully during this part of the process. You might want to consult a lawyer specializing in small business finances who is familiar with factoring to go through the agreement paperwork and make sure you understand various potential scenarios, such as what happens if you need to delay a payment.
Step 3: Assigning the Factor
Once the agreement has been signed, the factor will give you an advancement called the advance rate. Normally, this rate is a percentage of your invoice value. The amount you receive is usually around 80% of the total invoice value, and would be outlined in advance in your agreement with the factor. The rate you get is generally determined based on your industry, transaction history, and stability of your business.
Because invoice factoring involves re-assigning the receiver of your client’s bill, the company offering invoice factoring may send out a “notice of assignment” to your affected clients at this stage. The notice would inform them of your invoice factoring plan, and provide them detailed instructions on how to send future payments from invoices issued from you.
Step 4: Collection and Payment
As soon as your invoice’s deadline has passed and your client has paid the factor, the factoring company will send you any remaining balances, known as the reverse amount. To collect their own payment for their services, the factoring company will also deduct their service fee, also called a rebate, from the remittance. This fee is usually a percentage that you negotiate when drafting your factoring agreement, and this percentage is usually based on the total original invoice amount and the invoice due date.
How To Qualify For Invoice Factoring
Before you begin invoice factoring for your company, you’ll need to complete an application as required by the factoring company of your choice to find out if your business qualifies.
There are many components factoring companies look at within your company and invoices when determining the eligibility of your business. We’ll discuss all of the usual criteria here.
The number one determining factor that affects a company's eligibility in the eyes of a factor, is their customers themselves. Because factoring companies will be potentially taking on the financial risk and consequences of any unpaid invoices, factors want as much information as they can get to make a bet on whether your outstanding invoices will eventually be paid. There is always a possibility that some customers may not be able to pay their invoices, due to bankruptcy or poor planning.
Like any lender, factors do everything they can to avoid the risk of losing their capital. By asking you to provide information and answer financial questions about your invoices and customers, factoring companies are doing their due diligence to predict the potential loss they may face by agreeing to finance you.
How Much Does Invoice Factoring Cost?
Once a factoring company agrees to work with you, you will need to pay them for their invoice services in the form of factoring fees. That’s why, when you sell your invoices to a factor, you only get a percentage of the full invoice value. A typical factor advancement is around 80% of the invoice value, but this will vary depending on your agreement and the factor. You should always learn and negotiate the terms of these fees when you sign a factoring agreement. The fees are generally composed of two key components: the Discount Rate and the Factoring Period.
Discount Rate
The transaction fee or the primary cost of doing business with a factoring company is known as the discount rate, or the factor rate. Depending on the factor and the factoring period, it could range from two to 10 percent of the invoice. If you’re also dealing with a large amount of invoices within a given time frame, this rate could be lower. Always ask your factoring company about how their discount rate is determined, and what you can do to get the best rate.
As an example, let’s say that you have a $100,000 outstanding invoices due in 30 days, and you choose to factor it at a discount rate of 5%. You would receive $95,000 as your first advancement because the factor company has kept $5000 as their fee.
Factoring Period
The Factoring Period is the amount of time that a factoring company allows your customers to keep their invoices open. This information is relevant for you because it will affect the amount of fees you ultimately pay. Factors charge discount rates at regular intervals (typically weekly or monthly), so the factoring period, the length of time your customer takes to pay your invoice, will determine your final cost.
It’s important for you to work with the factor to set a realistic factoring period that works for you and your clients, because even if your clients do not pay back the invoice on time, in a “recourse factoring” agreement, the factor could begin collections from you to withdraw their fees. Consider the length of time it will take for your customer to pay your invoice when determining your costs.
For more about how “recourse” vs “non-recourse” factoring, see below, on Comparing Factoring Companies.
Invoice Factoring for Small Businesses
Invoice Factoring for small businesses is a great way to get paid on slow paying clients. Depending on how fast repayment comes in, it'll be easy to repay off money borrowed. With this extra influx of capital, one can then meet the demands of payroll, extra expenses, etc. It's possible this would be the last time this would need to be done too.
Factoring, Financing… What’s the best solution for your business?
For many small business owners, factoring is an attractive choice because the factoring company takes over the responsibilities of collections, freeing up more time for you to run your business. If you are experiencing collections problems, where your clients aren’t paying you on time, and you don’t know what else to do, then factoring could be a good solution since it puts that responsibility on a third party experienced in collections.
However, if you simply need to get paid faster but don’t want to lose control over your customer relationships and customer experience, invoice financing might be a better alternative for you and your clients. In today’s competitive business environment, customer experience counts for more than ever. Now there are services like Swift SBF which make invoice financing possible, more and more businesses are choosing invoice financing over invoice factoring.
Another reason businesses choose invoice financing over factoring is that financing tends to be more transparent in terms of fees and repayment policies. This transparency means fewer opportunities for surprises, and more accurate predictions of future expenses. Invoicing financing is a valuable tool for you, if you are running a growing company and are looking for more control over your cash flow.
The Swift SBF application and repayment processes are examples of transparency. With Swift SBF, there are no subscription, prepayment, or inactivity fees, and you only pay when you draw. Depending on the value of your invoices, Swift SBF fees start at 4.66% of the drawn funds. There is no early payment penalty: you actually pay fewer fees when you pay off your entire balance early.