Factoring Companies, What are They?

One of the most demanding tasks for businesses is to efficiently and responsibly manage invoices so that everything is paid on time. An additional challenge arises when, even if your company is on top of your bookkeeping, receiving timely payment for your invoices isn’t always a guarantee. This can negatively impact your workflow, company investments, supplier payments, payroll, and more.

A factoring company is a common solution for many businesses.  Instead of waiting on clients to make their payments on time (or early), you can rely on a factoring company to ensure that you have the necessary cash flow to keep your business running smoothly. This article will discuss what factoring companies are and how to select the right one for your business model.

What Does a Factoring Company Do?

Factoring is a transaction where one company sells one or more accounts receivable invoices (or assets) to a third-party financier, also known as a factor. Businesses do this to get quick cash flow, so they have the funds they need on hand. Instead of waiting for an unpaid invoice to mature and be paid, a business can sell the invoice to a factoring company for less than face value in exchange for instant access to funds.

Some businesses hesitate to sell their invoices for less than what they are technically worth, so why work with a factoring company? Even though a business is not paid the full amount of the invoice when they sell at a discount, it can be worth sacrificing a portion of the credit in order to pay operating expenses or accept new growth opportunities. For companies that are strapped for cash, using a factoring company as a financial tool is one way to get money fast without going into debt.

Here’s an example of how and why it works. Let’s say ABC Trucking Co. provides freight shipping services for Manufacturing LLC and issues an invoice totaling $20,000 that is due in 60 days. ABC Trucking is ready to expand its business but needs cash on hand to fuel trucks, pay employees, and maintain other business operations. They don’t want to wait 60 days to collect their earned revenue from Manufacturing LLC.

When put in this kind of situation, ABC Trucking Co. may decide to factor their Manufacturing LLC invoice. Per the terms of their factoring agreement (which vary by company and factor), ABC Trucking Co. may sell the invoice at a discount rate of 5%, for a total of $19,000. They then receive 80% of the invoice value ($16,000) as an advance when they turn over the invoice to their factor. That money can be used immediately to pay their business expenses or be invested in other ways. 

In 60 days, their factor collects the owed $20,000 from Manufacturing LLC and pays ABC Trucking Co. the remaining $3,000. ABC Trucking Co. might have many factored invoices open at a given time, depending on the number of clients they service and the payment terms they offer. Because of the factoring relationship, ABC Trucking Co. has access to the funds they need, when they need them, and does not have to decline opportunities due to a lack of working capital.

The Difference Between Invoice Factoring and Invoice Financing

People don’t always understand how invoice factoring is different from invoice financing (also called A/R financing), but it’s a simple distinction. Factoring is a sale, where the invoice or asset is sold to the bank or factoring company with no intent to get the asset or its full value back. It becomes the responsibility of the factor to collect the payment from the original customer.

Invoice financing is a revolving loan or line of credit, where a company borrows money from a lender and the funds are secured based on the value of one or more outstanding invoices. The responsibility of collecting the invoice balance remains with the borrowing company, which must then repay the lender once an invoice is paid by the customer.

Invoice financing takes your business’s creditworthiness into account, but invoice factoring lenders are typically more concerned with the creditworthiness of your company’s clients. For newer and smaller businesses that haven’t built much credit, factoring can be a good fit, while invoice financing is more suitable for larger businesses with an established credit profile and a portfolio of established customers.

What is Independent vs. Bank Factoring

Different types of third parties can take on the role of factor in these transactions, including banks and independent factoring companies that work with multiple funding sources. An independent factor must borrow funds from a third party to provide the money for invoices, which can add risk and cost to your business. A bank, on the other hand, is a single and direct source of funds that cuts out the middleman. Bank factoring tends to offer greater security and stability, competitive rates, and may also provide additional benefits such as a business bank account.

Best Factoring Companies

Factoring is a solid solution for a lot of businesses that need cash now and is best used during growth periods when your invoices and accounts receivable are plentiful. Instead of going from debt to debt and digging a deeper hole, factoring allows you to access the money you need without strict lending covenants. It isn’t for every business or scenario, but when you could benefit from this type of transaction, it’s essential to go with a trustworthy and established factoring company.

How do you choose the right factoring company? Especially if you’re new to factoring, you don’t want to unknowingly hitch your business to an unreliable source of funds. We’ve narrowed down the most important attributes of a factoring provider based on your business and needs.

Best for Small Businesses & Startups

Small businesses work within a tight budget even as they produce quality products and services. Reviewing multiple factors is essential to ensure that the offered rates help you retain the profit your company needs to survive.

If you’re just getting your company up and running, there are many expenses that come at you from every direction, and many unexpectedly. As you’re getting established, you need to invest in equipment, bring on the best staff, cover cash flow gaps, and invest in marketing strategies (among dozens of other responsibilities).

Look for features in a factor like:

• Non-recourse agreement. The last thing you want is to have to pay for your original customer’s invoice if they fail to pay when the due date rolls around. If you don’t have the money now, you don’t want to have to make up for it later and lose even more cash. Non-recourse factoring helps prevent bankruptcy and usually relies more on the customer’s ability to pay instead of your line of credit.
• Competitive rates. A small business can’t usually afford high rates, so look for competitive rates of less than 5% where possible.
• Specialized work with small businesses. You need a factor that speaks your language and understands your limitations as a small business. Find a factoring company or bank that has worked with small businesses and one that doesn’t have strict, unrealistic requirements. For example, a good factor for small businesses won’t require a minimum length of time that your business must be up and running before it can qualify for funding.
• Fast payments. When you’re dealing with a lot of unexpected or upfront costs in the beginning, you may need money faster than normal. There are factors that can get you your funds within 24 hours for those quick turnaround times.
• Credit history flexibility. A new business hasn’t had the time to establish a great credit profile or the opportunity to build history. Startups should especially find factors that will work with less-than-perfect credit profiles and focus more on your customer’s creditworthiness instead.

Best for Invoice Factoring

Factoring companies can work with all kinds of assets, but if you’re looking for invoice factoring specifically and want to prioritize usability and invoice management, here are the features we recommend when looking for the right factoring firm:

• Monitoring capabilities. Competitive invoice factoring providers offer an online experience and interface that includes client reporting, invoice payment statuses, and other helpful tools a great dashboard should have.
• Real-time updates. Advanced software should offer real-time updates so that you can easily understand where your funds are, whether your request has been processed, and more.
• Immediate customer service. Even though online portals are convenient, it’s also important that these systems have customer support available so that you have the help you need if something is wrong with your account, invoice, payment, etc. Some factors will even provide you a dedicated account or relationship manager whom you can contact directly with questions or concerns.

Best Overall

Not just any third-party factoring business will do when it comes to supporting your company. If you want the best of the best, look for a factor with the following attributes:

• Industry expertise. Find a factor that can work with you and your specific industry. For example, if you need trucking invoice factoring, there are specific pain points, frustrations, and needs that a specialized team with that expertise can address.
• Competitive rates. Of course, the best factors will offer competitive rates with flexible financing options, like having non-recourse and recourse factoring. Some factors will even offer advance rates of up to 100% of the discounted invoice value.
• Great customer service. Managing your finances is a stressful task and you need trustworthy and helpful support when getting funds. If you want the best experience, make sure the factor you work with treats its customers well and has positive customer reviews.
• Easy interface and digital access. In the modern world, an online portal where you can quickly access funds should be available to customers. This usually helps with quick turnaround times where businesses can get their funds within 24 hours of their request. The best of the best will offer some sort of software or portal for quick and easy access.

How to Know if a Factoring Company is Right for Your Business

Ultimately, a factor can help your business if you’re in a tight spot, especially for companies that are in the development phases. Having the cash you need when you need it can be more impactful and important than waiting months for full payment, especially if it means employees get paid on time, operations produce like normal, and you get the equipment and recipes you need to grow.

If you’re ready to make the most of your balance sheet and get quicker access to working capital, you can trust TAB Bank. With our easy-to-access online banking portal, you can get to your funds with ease. Plus, if you’re looking for a more customized experience, you’ll be assisted by a relationship manager to ensure your unique banking and financing needs are met. Whatever your factoring needs are, we’re ready to help you find the right invoice factoring solutions to keep your business thriving.

Learn more about TAB Bank invoice factoring today!