What Is Invoice Factoring And How Does It Work?

Most businesses have an invoice policy agreement with payment terms ranging from 30 to 90 days. That means if you send your client an invoice today, you’re likely to receive that money at least a month later, if not longer. With these payment cycles, most businesses run out of cash, which can be challenging to deal with necessary expenses like utility, inventory, and payroll, affecting its growth. This is where invoice factoring for small businesses comes in.

Invoice Factoring

What is Invoice Factoring?

Invoice factoring is a financing model where a business sells its outstanding invoices to a factoring company to maintain revenue stability as well as improve cash flow. After the factoring company buys the invoices, it will pay the small business an agreed percentage of the amount invoiced and follow up on the payment from your client.

Invoice factoring is also known as accounts receivable. The best thing about refinancing your business through this method is that it is a sale and not a debt, so there are zero chances of hurting your credit score.

How Invoice Factoring Works

Factoring for small businesses is a simple financing process that you can use if you invoice your clients.

Only three people are involved in this transaction;

The Seller (An eligible small business)
The Debtor (A business’ client)
The Factor (A company that buys the invoices)

Steps of Invoice Factoring

An invoice factor typically delivers two payments to a business. The first payment is when they purchase the invoice, and the second is after the customer pays the invoice.

Here are the basic steps:

The seller performs a service or sells a product to a client and then sends them an invoice.
The business will then present the accounts receivable to the factor, who will examine and determine its eligibility.
After the two businesses strike an agreement, the factoring company deposits its first payment to the small business’s bank account.
The Factor will start collecting payment from your customer.
When the buyer clears the debt, the factoring company will send the business the rest of the amount owed. The amount the seller receives by the end of the process should match that originally invoiced, less the factoring fee.

Benefits of Invoice Factoring for small businesses

Less stress for following up on payments: Since a factoring company will take responsibility for following up on the payment, you’ll be less stressed about collecting payments which can help you focus on your business growth.

Easier cash flow: Receiving money immediately after the sale enables you to re-invest it and increase your operations.

Cash advance: You don’t have to wait for up to 90 days for your clients to pay their invoices so that you can get utilities or pay your staff.