How Factoring Companies Provide Rapid Cash Advances

Traditional funding methods often fall short when your business needs a rapid cash advance. They can take weeks or months to pay, leaving you short on cash for crucial expenses like payroll and inventory. However, if your business generates B2B invoices, you have an alternate solution – invoice factoring. On this page, you’ll learn how factoring companies can provide instant capital, how the process works, and what differentiates it from other funding solutions.

Background: The Invoice Factoring Process

Invoice factoring, often called accounts receivable factoring, is a transaction in which the business sells its accounts receivable, or invoices, to a third party known as a factor or factoring company. In return, the business receives immediate cash, typically a percentage of the invoices’ total value. This allows the business to improve cash flow and meet immediate financial obligations.

How Factoring Works

Let’s say a small business completes a project or delivers goods to a customer. Instead of waiting for the customer to pay the invoice, which could take weeks or even months, the business sells the invoice to a factoring company at a slight discount. The factor advances a percentage of the invoice value, usually ranging from 60 to 95 percent. The factoring company then releases the remaining balance to the business minus a small fee when the client pays.

For example, a printing company in Ontario completes a project for a client worth $10,000. Instead of waiting 30 days for payment, which could strain their finances, they sell the invoice to a factor. The factor advances $8,500 upfront, or 85 percent of the invoice value. When the client pays the invoice within 30 to 90 days, the factor releases the remaining balance to the printing company minus their fee.

Comparing Factoring to Traditional Financing Methods

Factoring differs from traditional financing methods like bank loans and lines of credit for several reasons.

Speed and Accessibility

Invoice factoring offers quick access to cash compared to traditional financing. While bank loans or lines of credit may involve a lengthy application process and approval period, invoice factoring provides funds within days, sometimes even within 24 hours. This is crucial for industries like construction, where upfront costs for materials and labor can be substantial. Invoice factoring for construction companies provides a faster, more flexible option to maintain steady cash flow without the delays common in traditional loans.

Collateral Requirements

To secure the loan, traditional financing often requires collateral, such as real estate or equipment. In contrast, invoice factoring is backed by the invoices’ value, making it accessible to businesses that may lack substantial assets.

Creditworthiness

Banks typically evaluate a business’s creditworthiness when considering loan applications. This can be challenging for startups or businesses with less-than-perfect credit histories. Invoice factoring focuses more on the creditworthiness of the business’s customers as factors assess the likelihood of invoice payment. This makes it a viable option for companies with varying credit profiles.

Flexibility

Invoice factoring is flexible and grows with the business. The amount of funding available through factoring increases as sales and invoices increase, providing scalability. In contrast, traditional loans often have fixed terms and may not adjust to the changing needs of the business.

Cost

While invoice factoring may appear more expensive than traditional financing on the surface due to the discount applied to invoices, it’s essential to consider the overall cost of capital. Rather than using interest rates, factors typically charge a discount rate ranging from one to five percent of the invoice value. However, this cost is offset by the benefits of improved cash flow and the avoidance of interest payments associated with loans.

For example, a construction company in British Columbia needs $50,000 to purchase materials for a project. If they opt for a bank loan, they may need to provide collateral, undergo a credit check, and wait for approval, which could take weeks. On the other hand, with invoice factoring, they can sell $60,000 worth of invoices to a factor and receive around $51,000 upfront, providing immediate access to the required funds without the hurdles and pitfalls of traditional financing.

The Speed Advantage: Why Factoring Companies Are Faster

Factoring companies can provide funds faster than traditional financing sources primarily due to the transaction’s nature and evaluation process.

Simplified Underwriting Process

Factoring companies focus on the creditworthiness of the business’s customers rather than the business itself. Since they’re mainly concerned with the likelihood of invoice payment, they can streamline their underwriting process. This means less paperwork and faster decision-making than traditional lenders, who often assess a business’s financial history, credit score, and collateral.

Asset-Based Funding

Invoice factoring is asset-based funding. Unlike traditional lenders who may require extensive documentation and appraisal of collateral, factoring companies focus on the accounts receivable, which are tangible assets. This simplifies the evaluation process and allows for quicker funding.

Specialized Expertise

Factoring companies specialize in providing financing solutions tailored to the needs of small businesses, particularly those experiencing cash flow challenges. Their expertise in accounts receivable management and risk assessment enables them to expedite the funding process while mitigating potential risks.

Efficient Processes

Factoring companies have efficient systems in place for invoice verification, funding, and collection. They also leverage technology to automate repetitive tasks, such as invoice verification and payment processing, reducing the time it takes to complete transactions. Additionally, many factoring companies offer online platforms where businesses can submit invoices and track funding in real time, further expediting the process.

Focus on Business Cash Flow

Did you know that two in five small businesses have had to turn down opportunities due to cash flow issues, per Xero? Unlike traditional lenders, factoring companies prioritize providing immediate cash flow solutions to businesses. They understand the importance of timely access to funds for meeting operational expenses, investing in growth opportunities, and seizing market opportunities. This focus on cash flow enables them to expedite funding to meet the needs of their clients.

Timeline for Receiving Advances

Advances typically hit the business’s bank account via ACH in around two business days, though some factoring companies can provide same-day payouts. A typical timeline for funding through invoice factoring involves the steps outlined below.

Invoice Submission

The process begins when the business submits its invoices to the factoring company for funding. This can often be done electronically through an online portal or via email. The invoices should include details such as the customer’s name, invoice amount, payment terms, and other relevant information.

Verification and Approval

Upon receiving the invoices, the factoring company verifies the authenticity and validity of the invoices. This may involve confirming that the goods or services have been delivered as stated and that there are no disputes or discrepancies. Once verified, the factoring company approves the invoices for funding.

Advance

After approval, the factoring company advances a percentage of the invoice value to the business. This advance rate typically ranges from 65 to 90 percent, depending on various factors such as the industry, the creditworthiness of the customers, and the terms of the agreement between the business and the factor.

Funding

Once the advance is processed, the factoring company transfers the funds to the business’s bank account. This step can usually be completed within 24 to 48 hours of invoice approval, providing the business with immediate access to cash.

Customer Payment

The factoring company notifies the business’s customers of the change in payment instructions. Instead of remitting payments directly to the business, customers are instructed to pay the factoring company. This ensures that the factoring company can collect payment directly from the customers when the invoices become due.

Reserve Release

When the customers pay the invoices according to the agreed-upon terms, the factoring company releases the remaining balance, known as the reserve, to the business minus their fees. This typically occurs once the factoring company has received full payment from the customers, which can range from 30 to 90 days, depending on the invoice terms.

Fee Deduction

The factoring company deducts its fees from the reserve before releasing the remaining balance to the business. These fees typically include a discount rate applied to the invoice amount and additional administrative costs.

Get Immediate Capital Through Factoring

If your business can’t wait weeks or months for payment, invoice factoring can instantly turn your unpaid receivables into working capital. To learn more or get started, request a complimentary factoring quote.