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Debtor Factoring: The Essential Guide

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Small businesses that sell on credit often wait weeks to get paid. While waiting for your customers to pay their invoices, you still have bills to pay to keep your business running.

There are many working capital loans to consider when a company experiences cash flow shortages. Cash is the lifeblood of any business, and you need money on hand to cover expenses like rent and payroll.

Some companies use debtor financing to solve their working capital needs. There are several forms of debtor financing, but the most used is debt factoring. When a company uses debt factoring, it sells its outstanding invoices at a discounted rate for an immediate cash advance.

Is debt factoring right for your business? We can help you decide with answers to these questions:

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    What is Debt Factoring?

    Debt factoring is a business finance method where a company sells its unpaid invoices for immediate working capital. It is also called accounts receivables factoring, invoice factoring, or simply factoring receivables.

    A company’s unpaid invoices are an asset. But waiting for customers to pay creates cash flow interruptions. Using debt factoring, companies convert their outstanding invoices into cash.

    Let’s look at how debt factoring works.

    How does Debt Factoring work?

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    Debt factoring involves working with a third-party financing company called a debt factoring company or simply Factor. The Factor purchases the unpaid invoices at a discounted rate and provides a cash advance to the business.

    When the Factor purchases the invoices, it issues a cash advance based on the invoice value. The remaining amount goes into a reserve account.

    The Factor now owns the invoices and waits for your customers to pay. Customer payments go directly to Factor.

    Once the customer pays, the Factor releases the reserve amount minus its fees. The factor rate or discount rate is the primary fee the Factor charges. The discount rate determines how much of a discount the Factor gets when purchasing the invoices.

    Some companies charge additional factoring fees like an origination or early termination fee. Discuss any fees with the factoring company before accepting a factoring agreement.

    Debt Factoring Example

    XYZ Company has a factoring agreement with the following terms:

    • Discount rate: 2% every 30 days.
    • Advance rate: 90%

    XYZ factors invoices totaling $35,000. The Factor applies the 2% discount and purchases the invoices for $34,300. It then applies the 90% advance rate and issues a cash advance of $30,870.

    XYZ receives the cash advance via wire transfer in 24-48 hours. The Factor puts the remaining $3,430 into the reserve account.

    Once XYZ’s customers pay their invoices, the Factor releases the remaining amount.

    What is a Debt Factoring Company?

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    A factoring company, or Factor, is a financial institution that provides debt factoring services. Most factoring companies are fintech lenders or lending platforms.

    Many factoring companies act as ongoing partners to the invoice seller. Contracts are usually anywhere from six months to two years.

    During the contract period, the business factors its accounts receivable on an ongoing basis. The factoring company, in this case, acts as an extension of the business’s accounts receivable collections team.

    How do Factoring Companies differ?

    Each debt factoring company sets its own policies, fees, and processes. Let’s look at some of the key differences.

    Fee Structures

    Companies use either the invoice discounting method (described above) or charge a flat factoring fee. In invoice discounting, the factoring company takes its percentage off the top, and the advance rate is based on what’s left after the discount.

    The flat factoring method is a flat percentage of the total invoice amount, and the advance rate is based on the total. Companies that use invoice discounting typically have higher advance rates, whereas flat fee factors have lower advance rates.

    The factoring fee provides extra security for the company if a customer pays late. Most companies charge a monthly fee, but some charge it weekly.

    Recourse vs. Non-Recourse Factoring

    Recourse factoring means the factoring company has recourse if your customers don’t pay their invoices. The company can make you repurchase the invoice at the total amount.

    Non-recourse factoring means the company assumes liability if your customers don’t pay for a specified reason, such as bankruptcy. The specific conditions depend on each factoring company’s non-recourse policy. Non-recourse factoring is more expensive because the factoring company assumes a more significant risk.


    Some Factors cater to specific industries, such as trucking and freight. When a company specializes in an industry, it can offer additional benefits, such as a fuel card in the case of trucking.

    Notification Factoring

    Some factoring companies notify customers when buying out their invoices, while others don’t. If you prefer to maintain a direct relationship with your customers, look for a company that doesn’t use notification factoring.

    Additional Services

    Since the factoring company acts as an extension of your accounts receivable department, several offer additional A/R tools. Also, most debt factoring companies are online lenders and fintech companies, so they offer additional online tools and services. Examples include:

    • Easy invoice uploads.
    • Integration with your accounting software.
    • Credit checks on your customers.
    • A/R processing tools.
    • Online portals or mobile apps for convenient processing.

    Why do small businesses use Debt Factoring?

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    Small businesses usually turn to debt factoring when they face cash flow issues and can’t find another business loan option. Factoring provides several benefits to companies.

    Early Access to Working Capital

    The primary reason to use factoring is to access the cash tied up in receivables. The money is scheduled to go to your business, but you can’t cover daily operating expenses like payroll and rent without cash. Debt factoring provides early access to your cash so you can keep the business running smoothly.

    Improved Cash Flow Control

    You have no control over when your business receives customer payment. It might be on the due date, early, or even late. With debt factoring, you always know when you can access the cash, making it easier to plan and budget.

    Outsourcing Billing & Collections

    When a factoring company purchases your invoice, it becomes responsible for billing and processing payments. For some small businesses, having the factoring company handle the back-office accounts receivable work saves time and money.

    How to apply for Debt Factoring:

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    You can apply for debt factoring through United Capital Source. Follow these instructions to apply for debt factoring.

    Step 1: Make sure your customer is reliable

    Factoring invoices only works when your customers pay their invoices on time and in full. Ensure you’re certain your customers will pay before contacting a factoring company.

    Step 2: Gather your documentation

    When you apply, the factoring company needs to review the following documents:

    • Driver’s license.
    • Voided business check.
    • Banks statements from the previous three months.
    • Business tax return.
    • Accounts receivable aging report, Accounts payable report, debt schedule.

    Step 3: Apply

    You can complete our one-page application or give us a call to apply. Either way, you’ll need to provide the information above and the invoice amount you want to sell.

    Step 4: Speak to a representative

    Once you apply, one of our representatives will reach out to discuss the factoring rate, fees, and terms attached to the sale. You’ll get an upfront breakdown of all costs, so you don’t have to worry about hidden fees.

    Step 5: Receive approval

    The entire process takes about two weeks to finalize. Funds will appear in your bank account 1-2 days after completing the application.

    Frequently Asked Questions

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    Here are some of the most common questions about debt factoring.

    What are the other Debtor Finance options?

    Debt factoring is the most common form of debtors’ finance, but there are other options.

    Invoice Discounting

    Invoice discounting is like factoring, except that you keep ownership of your invoices. In this structure, the cash advance is a loan that adds to your company’s debt. This means businesses do need good credit to qualify. Small businesses tend to use debt factoring, while larger companies use invoice discounting.

    Reverse Factoring

    Reverse factoring is a supply chain finance solution. In reverse factoring, a larger company applies for factoring for its smaller suppliers. Once the factoring arrangement is established, it proceeds like standard factoring.

    Can I get Debt Factoring with bad credit?

    Yes, one of the benefits of debt factoring is the ability to gain business loans with bad credit. Most working capital loans require at least decent credit, but with factoring, the lender looks at your customer’s credit, not yours. That’s because payment ultimately comes from your customers. If the customers you invoice have good credit, you should be able to find a factoring company that can work for you.

    What are the advantages of Debt Factoring?

    The are various debt factoring advantages. Debt factoring qualifications are less stringent than business loans, and approval depends more on your customers’ credit than yours. Some factoring companies don’t require a minimum credit score making it a feasible solution for businesses that don’t qualify for a traditional loan.

    Debt factoring isn’t a loan, so you don’t incur any debt. It’s a viable alternative for companies in urgent need of funding that don’t want to add to their debt.

    Some companies prefer that the factoring company collects on the invoice. It can save time and money since the factor essentially acts as your collections department. Although, some businesses do prefer to maintain a direct relationship with their customers. If this applies to you, look for a company that doesn’t notify your customers when it acquires their invoices.

    The most significant benefit is turning accounts receivable into working capital. Unpaid invoices are like unsold inventory – the longer it goes without converting into cash for your business, the less profitable it becomes. Debt factoring lets you unlock that capital sooner for an immediate cash flow boost.

    What are the disadvantages of Debt Factoring?

    The biggest drawback is that debt factoring is more expensive than traditional loans. Like most near-term and short-term financing, debt factoring carries higher rates and fees than conventional long-term business financing.

    Due to the complex nature of receivables factoring, it’s also difficult to compare costs to a loan or other forms of financing. The time it takes for your customers to pay their invoices determines your factoring fee, so the cost could vary.

    While you don’t need good credit for approval, your customers do. If your customers are unreliable and already paying late, you are unlikely to get approved. Invoice factoring works best for companies that sell on credit to creditworthy businesses.

    Factoring receivables is not the only way to avoid late payments and convert invoices into cash. Sometimes all you need to do is improve billing. You can try automating your invoices, giving customers more ways to pay, and improving your collections team’s efforts.

    We prepared a pros and cons list for a quick summary.

    Pros & Cons:

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    • Turn unpaid invoices into cash.
    • Easier to qualify for than other business financing options.
    • You can use the funds for a variety of business purposes.
    • Invoices are collateral.


    • Higher rates & fees than traditional loans.
    • Fees are based on how long customers take to pay their invoices.

    Debt Factoring – Final Thoughts

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    Debt factoring is a viable working capital solution for small businesses that can’t qualify for a traditional business loan. The rates are costly, but it allows you to access the money in accounts receivable sooner to help solve cash flow needs.

    Large companies or small business owners with great credit can likely find cheaper financing with a different small business loan. However, debt factoring does allow companies to finance their business without incurring debt.

    Contact us if you’re ready to discuss debt factoring or another business loan for your company. Our loan experts will review your business goals and help you find the right solution for your financing needs.

    We will help you grow your small business.

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