Why Do Companies Use Invoice Factoring?

Last Updated October 22, 2024

Invoice factoring is not a new type of financing, but it is still a new concept to many business owners. Invoice factoring is an alternative financing solution in which a company sells its outstanding invoices to a third-party “factor” (also referred to as a “factoring company“) for a discounted rate in return for a cash advance. Factoring is used to inject working capital into a business quickly and without taking on debt. Companies use the cash they receive from factoring for a variety of reasons, including:

• To make payroll
• To pay rent
• To buy inventory or raw materials
• To hire more employees
• To take on new orders / clients

As a company grows and experiences an increased need for cash, they will likely seek out various forms of financing. Below are some of the most common reasons that we see business owners consider factoring services over other forms of funding:

They Have Slow Paying Customers on Long Payment Terms

Long payment terms are a common issue in the B2B industry. Net30 and Net60 invoice payment terms are standard, but business owners often find themselves needing cash before receiving payment from their customers. Additionally, customers may wait until the last day to pay their outstanding invoices, leaving businesses low on working capital and unable to meet various payment obligations.

With invoice factoring, companies do not have to wait for customers to pay them to receive cash. Instead, they can sell their invoices to a factoring company for a discounted rate in return for a cash advance. This allows businesses to access working capital when they need it, rather than being subject to the payment schedules of their customers.

They Need Scalable Financing

Invoice factoring is an excellent financing solution for a growing company. Unlike traditional bank loans and lines of credit, there is not a financing cap tied to factoring invoices. This is because instead of lending a company money, a factor advances a company the cash used to purchase their outstanding invoices, meaning they can factor more and more invoices as they bring on new customers, as long as those customers are creditworthy and reliable.

For this reason, many seasonal businesses turn to invoice factoring.

They Can’t Qualify for Traditional Loans Due to Bad Credit

Because the approval process for factoring primarily relies on the credit history of a company’s customers, rather than that of the company itself, companies with poor credit have a much easier time getting approved than with more traditional financing options.

But why do factoring companies care more about a business’ customers when going through the approval process? When a factor works with a new client and buys their outstanding invoices, they are not betting on the likelihood of their new client to pay them but are instead betting on the likelihood of their new client’s debtors to pay their invoices. So even if a business owner has bad credit, a factor is not assuming that risk. They are instead assuming the risk of the client’s debtors not paying their invoices.

Their Company Is Too New to Qualify for Traditional Loans

For a similar reason as for those with bad credit, new companies and startups often turn to invoice factoring because they do not have to have a long credit history to be approved. Instead, an invoice factoring company will look at their customers’ credit history to decide whether or not they will factor their invoices.

They Were Rejected for a Bank Loan for Another Reason

Bank loans are notoriously difficult to get approved for, especially for new businesses and those that do not have great business credit. Banks look at a company’s operational history, credit, and capital when they consider loan approval, which makes it difficult for startups to receive financing. Additionally, a company must have collateral as a means of securing the loan with a financial institution. If a business does not have the assets to secure a loan against, they will have a much more difficult time getting approval.

As mentioned above, invoice factoring does not require good credit or a long operational history. Similarly, a business does not need collateral to qualify for factoring either. Instead, a company needs reliable customers who will pay their invoices, making it much easier to qualify for.

Related: Factoring vs. Bank Loans

They Are Growing Quickly

Invoice factoring allows for flexibility in a company’s financing and growth. In addition to funding businesses quickly, many factoring companies will approve line increase requests as a company grows and needs access to additional capital. This financing flexibility helps startups accelerate more quickly as they can take on more customers more easily.

Why Companies Use Invoice Factoring FAQs

Still have questions about why a company may choose invoice factoring as their primary financing solution? We’ve answered some of the most common questions below.

What is the purpose of invoice factoring?

Invoice factoring is an alternative financing solution that helps businesses access working capital without taking on debt. It is a suitable funding option for companies that cannot get a bank loan and/or need to improve cash flow.

What types of businesses use invoice factoring?

All sorts of businesses use invoice factoring to access working capital. Typically business-to-business (B2B) companies benefit the most from factoring services, and common industries that leverage factoring include staffing, wholesale, fabrication, professional services, and transportation. However, factors like altLINE often create customized funding solutions for businesses, so even if your company does not fall within one of the listed industries, you can likely still benefit from factoring.

Do I have to factor all of my invoices?

You do not have to factor all of your invoices. Many companies only factor some of their invoices, and others may even use single invoice factoring (also known as “spot factoring”) to receive funding for only their largest accounts receivables.