How Does Invoice Factoring Work For Your Business?

Matthew Gillman

Updated: October 12, 2018
What is invoice factoring

Invoice factoring is a process of selling invoices to a factor company. Typically in business, you make a deal with your client and set up terms for payment. But what happens if you need money before the terms are up. Many small business owners use invoice factoring to cover their cash needs quickly, which eliminates the need to borrow.

Invoice factoring is all about taking advantage of relationships. There are three key relationships that we will discuss in this article: The relationship between you and your client, the relationship between you and the factoring company, and, between your client and the factor. By understanding these three relationships, you can take advantage of the benefits invoice factoring offers you.

You and Your Client

As a small business owner, you know that relationships are key. By fostering positive relationships, you put your small business in a position to grow and succeed. Your relationships with clients will prevent your company from failing. Utilizing those relationships and turning them into lasting, repeat deals and contracts is key for small business owners.

Invoice factoring is all about taking advantage of the relationships you have made as a small business owner. Because of your success in building relationships with your clients, you have contracts and agreements with them. Repeat business is key for any company. With invoice factoring, you can turn your contracts into immediate resources by selling your invoices. From the aspect of your client, it is business as usual. You invoice your customers, set up terms of agreement, and wait for them to pay. They get their end of the agreement just like any other deal.

You and the Factor 

Another important relationship with invoice factoring is the relationship between you and the factoring company. When you look for factors, there are a number of things to consider.

First, the factoring company will want to look over your credit history to see if you are eligible. By establishing a good relationship with a factoring company, future business arrangements will be smooth. The factor wants to protect their risk, as does all who carry out financial transactions. By showing them you are a reliable business owner and following through on your end of the deal, you can establish lasting working relationships that ensures future success.

After the factoring company considers your risk and determines you are eligible, you will create a factoring agreement. The terms of the agreement will establish the initial payment, the fees on the transaction, along with the other details in the deal.

When you reach an agreement and sign a deal with the factor, you will receive an immediate advance from your accounts receivable. Different factor companies will offer you a different initial advance amount. After you sell your invoice, your customer pays the money owed to the factoring company instead of to you. Once they are paid, the factoring company pays you the difference between the invoice total and the initial advance, minus the agreed fee amount.

Your Client and the Factor

The third relationship to consider is between your client and the factoring company. Before agreeing to purchase your invoices, the factoring company will look into the credit and business history of each of your customers. If there are no problems, this might be the extent of the relationship between the factor and your client.

Sometimes a factoring company will send out a notice of assignment to your clients once an invoice factoring agreement is made. The notice would let your client know that the payment on the invoice is to be made to the factor instead of you. In some industries, invoice factoring is common and the factor notice might not matter. Because the payment on the invoice will be made to the factoring company, the relationship between your client and the factor is something to consider.

Is Invoice Factoring Right for Me?

Invoice factoring is great for small business owners with high quantities of accounts receivables. Many companies are held back by restrictions on financing options, like credit history or annual revenue. Because invoice factoring involves selling invoices, rather than taking out loans, the qualifications are much easier to fulfill. Especially if your small business deals with a large amount of invoices. If this describes your business situation, consider invoice factoring to solve your cash problems.

Matthew Gillman
Matthew Gillman is the founder and CEO of SMB Compass, a bespoke business financing company focused on providing financing and education to small businesses across the U.S. The company has provided over $250 million to more than 1,250 businesses. Coming from a family of small business owners sparked Matthew’s passion to not only become an entrepreneur, but also to work with his fellow entrepreneurs to build long-lasting relationships.

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