How Does Factoring Work?
Factoring is a type of financing that helps improve the cash flow of companies that have slow-paying invoices. Usually, a factoring company purchases the accounts receivable of the client. This purchase gives the client access to immediate funds which can be used to pay for business expenses.
This solution has a number of advantages and few disadvantages (learn the pros and cons). Qualifying for invoice factoring is relatively easy and can be done quickly. These benefits can make receivables factoring a ideal alternative for new and growing companies with a cash flow shortage.
How does a factoring company buy invoices?
Most factoring companies purchase invoices in two installments. The first installment – the factoring advance – covers about 80% of the receivable (this amount varies). The remaining 20%, less the factoring fee, is rebated as soon as your client pays the invoice in full. Here are the steps:
- You submit the invoices for purchasing
- The factoring company sends you the advance (e.g., 80% of the invoice)
- Your client pays 30 to 60 days later
- The factoring company sends you the rebate (e.g., 20%, less the fee)
However, before you can begin financing your invoices, you must select a finance company and set up an account.
Step #1: Finding a factoring company
Begin the process by looking for a company that meets your financing needs. There are many providers with experience in a number of industries. Look for one that has experience in your industry and has worked with your customers. Evaluate your options and choose the best factoring company for your business.
Step #2: Setting up a factoring account
Setting up an account with a factoring company is relatively simple. You need to review your contract and all legal documents. Once they are signed, the factor finishes its due diligence, files a UCC statement, and sends out the notices of assignment. This process can take from one to three days, depending on your circumstances.
Step 3: First funding – getting your money
Once your account is set up, you are ready to get funded. Usually, companies sell their receivables to the factor by submitting them with a schedule of accounts. The schedule of accounts lists the invoices that you want to sell.
After receiving the schedule of accounts, the factor verifies the invoices and sends the advance to you. The advance is the first installment of the purchase. Depending on your industry, the advance ranges from 70% to 95% of the gross value of your invoice.
Most clients get their funds via direct deposit, also known as an ACH. An ACH can take a day or two to clear your bank account. If you need funds sooner, ask for a wire transfer. A wire transfer clears your account within one business day or less.
Step #4: Getting the rebate
The factoring rebate settles the transaction. The rebate is the second installment of the transaction and can be for 5% to 30% of your invoice, depending on the size of your initial advance. Factoring companies have a different way of handling the rebate. Some distribute the rebate as soon as your customer pays in full. Others “batch” rebates and provide them weekly or on some other schedule.
Step #5: Ongoing financing
Companies usually factor invoices regularly. This practice provides them with ongoing and predictable cash flow. The process is relatively simple. You send the invoices and a schedule of accounts. The factor processes your invoices and you get the advance. Once your clients pay, the factor settles accounts and sends you the rebate.
Get more information
We can provide you with high advances at low rates. For information, get an online quote or call (800) 801- 6919.