Last Updated on September 11, 2023
If your business has struggled with cash flow problems, you may have considered various forms of alternative lending. However, invoice factoring is a unique service that’s quite different from other cash flow financing. Here are some of the common questions we hear about factoring companies.
What Does a Factoring Company Do?
A factoring company specializes in invoice factoring, or purchasing outstanding invoices from businesses that have slow paying customers and are looking to boost cash flow. This allows a business to access cash flow immediately after issuing an invoice, instead of waiting 30-90 days for the customer to pay. Once they purchase a business’s invoices, they collect directly from the business’s customers.
Factoring companies are not one-size-fits-all. In fact, many focus on specific industries like trucking, construction or staffing. Some banks offer factoring services, but the majority of factoring companies are independent providers. Generally, firms that would benefit from a factoring service are firms that depend on credit sales and have slow-paying clients.
What do companies use cash advances for? Here are some examples of how factoring helps in business transactions:
- Fund raw material and inventory item purchases
- Buy new assets and equipment
- Grow your business further
- Cover advertising and marketing costs
Why Use A Factoring Company?
Companies use a factoring company to accelerate payment schedules when clients are slow to pay. According to Tywanna Maye, an Account Manager at altLINE, invoice factoring “creates a positive cash flow because by selling invoices, the company is paid immediately instead of waiting on their customers to pay them.” Instead of waiting 30, 60, or even 90 days, they can receive a large portion of the owed amount within 1 or 2 days. This helps alleviate cash flow issues caused by late invoice payments.
Additionally, invoice factoring can be easier to qualify for than traditional financing, like bank lines of credit or business loans. Tywanna explains, “It has less stringent requirements than traditional lending. Factoring also provides quicker access to working capital since the business is able factor invoices on a daily, weekly or monthly basis as needed.”
How Does A Factoring Company Make Money?
A factoring company makes money through factoring fees. When a business factors its invoices, the factor (or factoring company) advances up to 90% of the invoice value to the business. When the factor collects the full payment from the end customer, they return the remaining 10% to the business minus a factoring fee. That fee is typically between 1% and 5% depending on multiple factors, like the age of the invoice.
What Percentage Do Factoring Companies Take?
Most factoring companies take 1-5% of your invoice value based on your total factoring volume, client creditworthiness, business stability, and other considerations.
What Makes A Factoring Company Different From A Traditional Lender?
Factoring companies are different from traditional lenders because they do not provide a loan – instead, they purchase assets (i.e., your invoices). Therefore, you do not incur a debt, and your agreement and use of the line do not impact your credit score (aside from the impact from the initial credit check.)
What Is A Factoring Agent?
A factoring agent is an intermediary agent that provides cash or financing to companies by purchasing the account receivable. In exchange for your account receivable and factoring fee, the agent provides a cash advance, typically worth up to 90% of the invoice’s value, within 1 or 2 days.
What Industries Do Factoring Companies Serve?
Companies typically specialize in a few industries, but altLINE works with the following:
How Do Factoring Companies Calculate Their Fees?
Factoring fees generally range from 1-5% and are calculated based on a number of elements:
The Amount of Money Being Factored
Like most businesses, economies of scale are at play for factoring companies as well. Many of the costs associated with establishing and maintaining a factoring relationship are fixed in nature, so the more a factoring client utilizes its line, the lower their rates will be.
The Length of Your Invoice Terms
Factoring companies charge higher rates for invoices with longer payment terms (i.e. 60-90 days). This is because they’re advancing cash to your business for a longer period of time, and that time has value to the factor.
The Credit Quality of Your Customer(s)
Your customers are the ones who will pay the invoices you’re factoring. Therefore, the factoring company will want to ensure that your customers are good for the money. Better credit will result in lower factoring fees, and vice versa.
How to Choose a Factoring Company
No two factoring companies do things exactly the same – they specialize in different industries, offer different terms and use different language. These differences make comparing factoring companies difficult.
When you begin your research to find the best factoring company, ask these five questions first:
- How long have they been in business?
- What are their terms, fees and funding limits?
- How frequently and quickly will your invoices be funded and payments applied?
- How will they interact with your customers?
- Where are their funds coming from (are they a bank, or a middleman?)
Find out more about how to choose a factoring company.
What Factoring Companies Should I Avoid?
Above all, avoid any factoring company that you don’t feel you can trust. Are they slipping additional fees into your factoring contract (like unused line fees, renewal fees, and monthly minimums)? Are you concerned that they won’t represent your business appropriately when collecting outstanding invoices from your customers? Do they have consistently negative online reviews? These are the kinds of companies you should avoid when selling your receivables.
Are Factoring Companies Predatory?
No, there are plenty of good providers out there. Invoice factoring can get a bad reputation from some disenchanted customers, largely because of outlying dishonest factoring companies employing shady tactics. However, factoring has been around for centuries, and when done right with transparency, reliability and trust, it’s a great option for many businesses.
Does it matter if the company is near me?
Not particularly. When you factor your invoices, everything can be done digitally or via mail. While you may find that a local factoring company is more appealing or trustworthy, most factors provide services nationally (and some internationally.) The most important thing is to find a factoring provider that you trust.
Is Factoring A Good Idea?
Factoring is a good idea if your company frequently deals with late client payments and cash flow issues. It can accelerate client payment cycles to ensure you can pay employees, buy supplies, and grow your company without going into debt.
What Types of Businesses Use Factoring Companies?
Several types of companies use invoice factoring, but you will typically see business-to-business (B2B) companies using it the most. One of the primary benefits of factoring as an alternative financing method is that you can access cash quickly, without waiting for your customers to pay your outstanding invoices. Because many B2B companies function by selling their goods or services to other companies on credit, they often find themselves needing working capital prior to receiving payment from their customers, and factoring their invoices helps them improve their cash flows to grow their businesses.
While there are many types of industries that can benefit from invoice factoring, some of the most common ones are staffing, healthcare, transportation, manufacturing, professional services, wholesale, distribution, logistics, and fabrication.
Factoring companies for freight brokers are especially important because they often need a reliable cash flow to support business operations. Factoring companies for truck drivers are essential for the same reason – drivers need to pay for regular vehicle maintenance to continue working. However, freight shippers and clients sometimes take a long time to pay, which might jeopardize the driver or broker’s day-to-day operations.
However, if your company is in a different industry, factoring still may be a great solution for you! We recommend filling out a quote and speaking with one of our representatives to better understand if a factoring company can help your business.
Jim is the General Manager of altLINE by The Southern Bank. altLINE partners with lenders nationwide to provide invoice factoring and accounts receivable financing to their small and medium-sized business customers. altLINE is a direct bank lender and a division of The Southern Bank Company, a community bank originally founded in 1936.