Factoring companies converts outstanding invoices into cash for small businesses. It’s a type of financing that is due in 30, 60, or 90 days. The factoring company pays in two installments for a specific invoice for roughly 80% of the invoice, plus 20% after the invoice is paid. The factoring fees are deducted from those 20%.
Factoring companies is also referred to as accounts receivable financing or debt factoring company. It’s a form of financing that is available to businesses that provide goods and services to other companies (B2B) or government agencies (B2G). Factoring companies works in the following order. First the B2B or B2G customer places an order with the small business. Then that business delivers the order and provides the customer with an invoice which is sold to a factor. The factor pays the business 70-90% of the invoice. The balance, minus the fees, is paid after the customer pays the invoice which can last for 30 to 90 days.
The factored invoice represents the customers promise to pay for the goods or services already delivered. Factors will lend money to these invoices if it is very likely that the customers will pay rather than skipping out on the bill. Factoring companies is a solution to short term cash flow issues, giving the customers time to pay for the goods at a later date. Extending net terms and invoice issuing can help gain an edge on the competition and increase sales. Factors will have a limit on the amount they will advance.
Any B2B or B2G with creditworthy customers can qualify for factoring companies if the invoice is payable within 90 days or less and if there were no serious legal or tax problems. Other requirements may vary by providers.
The cost of factoring companies has two factors.
The discount rate and the length of factoring period. The discount rate, or discount fee, is the cost of borrowing money from the factor and it’s charged weekly or monthly. The average for industries is from 1.5% to 5% of the invoice per month. Businesses with a larger volume of invoices and a history with a factor can qualify for better rates.
Discount rates are charged at weekly or monthly intervals, so the time it takes to pay the invoice will determine the cost.
Some factors charge additional fees. These can come in a form like: factor fees, application fees, and overdue fees if the customer is late with the payment, credit check fees for the business and the client, mailing fees if the factor contacts the client, etc.