Small Business Factoring: Converting Receivables into Cash

What is Factoring for Small Businesses?

Invoice factoring is a financing strategy in which a company sells its unpaid or outstanding invoices to a third-party lending institution for a cash advance. The lender issues an advance as a percentage of the invoice’s value. Small businesses can typically receive a cash advance of 70% to 95% of the invoice value when they factor invoices. In most cases, the funds are transferred to your business bank account.

The lender owns the invoice and collects payment at the due date. Once the customer pays the outstanding invoice, the lender releases the remaining amount to the company that sold the invoice.

Invoice factoring is also called accounts receivable factoring, receivable financing, or simply factoring receivables. The term is also used interchangeably with invoice financing, although that’s a different structure (more on that later). Accounts receivable financing and receivable financing are related funding options that use unpaid or outstanding invoices as collateral to provide cash flow. It’s one form of accounts receivable financing.

Invoice discounting is another alternative to invoice factoring, where businesses can secure early payment on invoices while retaining control over their customer relationships, as the customer is often unaware of the financing arrangement.

Why do small businesses use Invoice Factoring?

Factoring is particularly useful for small businesses. Many small businesses find themselves in a catch-22, needing working capital for daily operations while trying to grow and expand, yet not being large enough to qualify for traditional financing.

Factoring allows small businesses to convert receivables into business cash flow before their customers pay the invoice. That influx of cash is a valuable lifeline when a company struggles to cover expenses. Invoice factoring provides immediate working capital and is a popular funding solution for small businesses that need quick access to cash.

Many small businesses prefer invoice factoring over traditional loans due to faster access to cash and fewer eligibility requirements. Small business invoice factoring can help businesses meet payroll obligations and pay operating expenses promptly, offering a quick cash solution compared to other funding options.

Small businesses also use factoring as a bridge loan until they become eligible for more traditional financing. It enables small businesses to remain operational during periods of cash flow gaps.

What is an Invoice Factoring Company?

A factoring company is a lending institution that provides invoice factoring services. An invoice factoring service involves the factoring company taking responsibility for collecting payments and managing the receivables. Most factoring companies are fintech businesses, although some banks also offer factoring. For example, the popular factoring company altLINE is a division of the Southern Bank.

Factoring companies purchase outstanding invoices, provide cash advances, and collect invoice payments. In some ways, the factoring company acts as a business’s back-office accounts receivable. In contract factoring, a long-term arrangement, the factoring company takes on a bulk of invoices, often requiring minimum volumes and offering less flexibility compared to spot factoring.

Let’s examine some of the key differences between various invoice factoring companies.

Factoring Fees

The first thing to consider is the cost. Invoice factoring will always be an expensive way to secure financing, but some companies are far more costly than others. Invoice factoring rates and fees are typically calculated as a percentage of the invoice face value, so understanding the factoring cost structure is crucial. You want to ensure that you can afford the fees and that the cost of financing is worthwhile for your business.

Recourse vs. Non-Recourse

Recourse factoring means your company is liable if your customers default on their invoices. A recourse factoring agreement is a contractual arrangement where, if the customer does not pay the invoice within the agreed factoring period, the factoring company can seek reimbursement or collection efforts from your business, increasing your financial responsibility and potential costs. In non-recourse factoring, you don’t have to pay if your customers default due to specified reasons such as bankruptcy. Non-recourse factoring is more expensive, but the added protection may make it worthwhile.

Notification Factoring

Some factoring companies will notify your customers when they purchase the invoices, and others will not. If you don’t want your customers alerted when you sell their invoices, look for a company that doesn’t notify them. UCS doesn’t use notification factoring.

Additional Services

Some invoice factoring companies stand out because they offer enhanced services to help you process invoices. Some additional services to consider when looking for a factoring company 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.

How does Invoice Factoring for Small Business work?

Invoice factoring is not a loan but rather a sale of accounts receivable to another company. Accounts receivable represent future money that will come into a business and, as such, are recorded as an asset.

Like any asset, accounts receivable carry value, and factoring is a method to liquidate that asset into cash. The process of converting the asset into cash requires working with a factoring company.

As mentioned, factoring companies are specialized lenders that recognize the value of accounts receivable and have the infrastructure to collect payments. When a business partners with a factoring company, it enters into an invoice factoring agreement, a contract in which the business sells its outstanding or unpaid invoices to the factoring company in exchange for immediate cash. These agreements outline key terms, including recourse or non-recourse factoring, buy-back obligations, and payment structures.

Factoring agreements include all rates and fees as well as terms and conditions. Carefully read any factoring agreement before signing it.

The company will likely discuss the terms with a business before asking to sign the agreement. Specific information in the agreement includes:

• Discount or factor rate: The percentage the factoring company keeps as payment.
• Advance rate: the percentage of the invoice value that determines the cash advance.
• Additional fees: Origination fee, filing fee, etc.
• Minimum monthly volume: The number of invoices required per month (in dollars).
• Recourse or non-recourse factoring.
• Whole ledger, partial, or spot factoring.

Once a business signs a factoring agreement, it begins factoring invoices. The steps in factoring go:

1. Deliver the goods or services to the customer.
2. Invoice the customer, including the purpose, price, and due date.
3. Send the factored invoices, which are the outstanding or unpaid invoices, to the factoring company.
4. After approval, the factoring company establishes a credit limit, which is the maximum amount of funds the business can access. Then it sends the cash advance to the business’s bank account.
5. The factoring company then waits for the customer to pay.
6. After receiving payment from the customer, the factoring company releases the remaining invoice amount after deducting factoring fees.

Factoring Example

ABC Web Services is a boutique IT and marketing agency that provides professional website development for brick-and-mortar businesses looking to expand with an eCommerce platform. They offer marketing services, web design, and analytics. Its main competitive advantage is the proprietary software it uses to run eCommerce.

Clients typically pay their invoices monthly. ABC offers net 30 terms as an attractive incentive when onboarding new clients. The idea is that ABC gets the website up and running, generating revenue, before the client pays.

And the pitch worked. ABC closed more clients when offering generous payment terms. Bringing on more clients leads to hiring more staff to handle the work, increasing server costs, paying more rent for a larger workspace, and other associated expenses.

The booming business is excellent, but ABC may face cash flow gaps that could derail its positive momentum. The firm is still young, and its small ownership group collectively has limited credit.

The agency’s clients have established businesses with a strong credit history. When a factoring company considers an application, it examines the client’s credit history, as they’re the ones who will ultimately repay the cash advance. However, maintaining a solid business credit history remains important for ABC, as it can enhance access to other financing options and bolster its financial credibility.

ABC Web Services gets approved for a factoring agreement with the following terms:

• Discount Rate: 2%
• Advance Rate: 90%

The agency factors receivables totaling $75,000. The factoring company applies the 2% discount rate and purchases the receivables for $73,500.

It then applies the 90% advance rate to the invoice face value and issues a cash advance of $67,500. ABC receives the cash advance via ACH transfer within 24 to 48 hours.

The remaining $7,350 goes into a reserve account. The reserve acts as security in case the clients are late with their payments. The 2% discount rate applies every 30 days the customer doesn’t pay. Therefore, if a customer is late, the additional charges are deducted from the reserve account.

Fortunately, ABC Web Services’ clients are reliable and pay on time. The factoring company releases the remaining amount.

Industry Use Cases for Factoring

Invoice factoring is a flexible financing tool that serves a wide range of industries, especially those that struggle with cash flow gaps due to slow-paying customers or extended payment terms. Here are some of the most common industry use cases for factoring:

• Transportation and Trucking: Trucking companies often wait weeks or even months for customer payments, making it challenging to cover immediate expenses like fuel, maintenance, and driver wages. By using invoice factoring, these businesses can factor invoices and receive quick cash flow to keep their operations running smoothly.
• Construction and Contracting: Contractors frequently face delays between project milestones and final payments. Invoice factoring helps bridge these cash flow gaps, allowing them to pay for materials, subcontractors, and equipment rentals without waiting for customer payments.
• Manufacturing and Wholesale: Manufacturers and wholesalers typically incur substantial upfront costs for production and inventory. Factoring invoices enables them to access working capital tied up in outstanding invoices, allowing them to fulfill new orders and manage day-to-day expenses.
• Staffing and Recruitment Agencies: Staffing firms must pay employees on a weekly or biweekly basis, but client companies may not pay for 30 to 60 days. Invoice factoring provides the immediate cash flow needed to meet payroll and grow the business, even with slow-paying customers.
• Healthcare and Medical Services: Medical providers, clinics, and home healthcare agencies often wait months for insurance reimbursements or government payments. Factoring invoices allows them to maintain steady cash flow, pay staff, and invest in patient care without financial stress.

By leveraging invoice factoring, businesses in these industries can overcome cash flow challenges, reduce the impact of slow customer payments, and focus on growth and service delivery.

What Factoring Companies are best for small businesses?

There’s no definitive way to determine the best small business factoring company for your business. Each company offers unique advantages and disadvantages. Many factoring companies provide invoice factoring as a specialized service for small businesses, enabling them to access quick funding through accounts receivable financing and other receivable financing options.

That being said, we can help identify the most reputable invoice factoring companies. You can review our lists of the best overall factoring companies and the best factoring companies for trucking. Here are the five best factoring companies for small businesses.

altLINE

• Advance Rate: 85%-95%
• Discount rate: 0.5% – 5%
• Funding time: 1-3 business days, but varies

altLINE is the invoice factoring wing of The Southern Bank, based in Alabama. Since the community bank funds altLINE’s invoice factoring, it can maintain competitive rates.

The factoring company’s advance rates range from 85% to 90%, and their discount rates start as low as 0.5%. The discount rate caps out at 5% if customers take longer than 30 days to pay their invoices.

altLINE does not offer invoice factoring to trucking or freight companies, which is uncommon in invoice factoring. It does provide excellent rates for all other industries, though.

Applying to altLINE:

You can complete the questionnaire on altLINE’s website to get a quote. A specialist from the company will call you back to discuss your options.

altLINE does not require a minimum credit score or a specified time in business. It does require a minimum monthly revenue of $15,000.

Triumph

• Advance Rate: Up to 100%
• Discount rate: 1%-4%
• Funding time: 24-48 hours.

Triumph Business Capital specializes in invoice factoring for trucking and freight companies. The trucking industry utilizes invoice factoring more than any other industry. The company is based in Texas.

Triumph offers additional incentives like a fuel card program, insurance, and equipment financing. The company also offers invoice factoring to staffing companies, as well as to businesses in the oil and gas, manufacturing, telecommunications, and service sectors.

Triumph’s discount rates range from 1% to 4%, and it offers a 100% advance rate with no reserves. It offers both recourse and non-recourse financing.

In some cases, it’s possible to receive same-day funding. Complete the online application or call Triumph to apply.

Riviera Finance

• Advance Rate: up to 95%
• Discount rate: starts at 2%
• Funding time: 24 hours

Riviera Finance offers non-recourse factoring, and it is one of the longest-running factoring companies available. The company’s unique credit guarantee distinguishes it from other factoring companies. Riviera Finance is headquartered in California.

The company’s credit management service guarantees credit on all invoices, so Riviera Finance assumes the risk as the credit manager. Companies factoring invoices through Riviera gain peace of mind knowing they are not responsible if a customer fails to pay their invoice.

Riviera Finance offers a convenient online portal with 24/7 access to your invoice information. The company uses integrated tools to provide support as an accounts receivables partner.

It’s also a good option for businesses that need funds quickly. Once approved, the company provides funding for invoices within 24 hours. Advance rates go up to 95%.

Applying to Riviera Finance:

You can apply in person at one of the company’s 25 locations, complete an online application, or call them directly.

Riviera does not have minimum requirements for credit score, time in business, or revenue. Credit decisions are based on your customer’s creditworthiness.

eCapital

• Advance Rate: up to 100%
• Discount rate: Starts at 1%
• Funding time: Same day to 48 hours

eCapital Commercial Finance offers a range of business financing products, including invoice factoring. The company is ideal for startups and younger businesses, as it doesn’t have minimum requirements that would generally exclude these businesses. Its headquarters are in Florida.

The factoring company offers advance rates of up to 100%, which is one of the best in the industry. Discount rates range from 1% to 5%, and they currently offer a 90-day trial period.

eCapital offers both recourse and non-recourse invoice factoring. The company offers some of the fastest funding times in the industry, with same-day funding available in select cases.

Invoice factoring customers gain access to eCapital’s database of over 40,000 companies and can run unlimited credit checks. The tool allows small business owners to run credit checks on their customers before factoring their invoices.

Applying to eCapital:

Complete an online questionnaire and then speak to a company representative. It’s possible to get approved and funded the same day you apply.

eCapital does not have minimum requirements. Any business with a verifiable invoice can apply.

How to apply for Invoice Factoring:

You can apply for invoice factoring through United Capital Source. Follow these instructions to apply for invoice 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.
• Bank statements from the previous three months.
• Business tax return.
• Accounts receivable aging report, Accounts payable report, and debt schedule.

Step 3: Apply

You can complete our one-page application or call us 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 contact you to discuss the factoring fee, factoring rate, and terms associated with 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.

What are the advantages of Small Business Factoring?

Invoice factoring qualifications are less stringent than those for a loan, and approval depends more on your customers’ creditworthiness than on your own. Some factoring companies don’t require a minimum credit score.

Invoice 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 collect on the invoice. It can save time and money since the factor essentially acts as your collections department. However, 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 immediate working capital. Unpaid invoices are like unsold inventory – the longer they go without converting into cash for your business, the less profitable they become. Invoice factoring allows you to unlock that capital sooner, enabling you to reinvest it in your business. Additionally, factoring only uses your accounts receivable as collateral, so your other business assets—such as equipment, inventory, or real estate—are protected.

What are the disadvantages of Small Business Factoring?

The biggest drawback is that invoice factoring is more expensive than traditional loans. Like most near-term and short-term financing options, factoring costs, invoice factoring costs, and invoice factoring rates can be higher than those of other financing options, with higher rates and fees than conventional business loans.

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 that the cost may 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 is most effective for companies that sell on credit to creditworthy businesses.

Factoring accounts receivable 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, offering customers more payment options, and enhancing your collections team’s efforts.

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

Pros & Cons:

Pros:

• Turn unpaid invoices into cash.
• Advances are typically a percentage of the invoice face value.
• Easier to qualify for than other business financing options.
• You can use the funds for various business purposes.
• Invoices are the collateral.

Cons:

• Higher rates & fees than traditional loans.
• Fees are based on the time it takes customers to pay their invoices.

Frequently Asked Questions

Here are some of the most common questions about factoring.

What are the best practices & common mistakes to avoid?

To get the most out of invoice factoring and ensure it supports your business goals, it’s important to follow some proven best practices:

1. Choose a Reputable Factoring Company: Take the time to research and compare factoring companies. Look for a reputable factoring company with transparent terms, competitive rates, and experience in your industry. Reading reviews and asking for referrals can help you find a trustworthy partner.
2. Understand the Factoring Agreement: Before signing, carefully review the factoring agreement to ensure you understand its terms. Pay close attention to the advance rate, factoring fees, recourse or non-recourse factoring options, and any additional charges or penalties. Ensure you understand all terms to avoid any surprises.
3. Maintain Good Customer Relationships: Since the factoring company may interact directly with your customers to collect payments, it’s essential to maintain positive and professional customer relationships. Clear communication can help ensure a smooth process and protect your reputation.
4. Monitor Cash Flow and Finances: Regularly review your cash flow and financial needs to determine when it makes sense to factor invoices. Strategic use of invoice factoring can help you cover short-term expenses and invest in growth, while avoiding unnecessary costs.
5. Consider Non-Recourse Factoring: If you want to minimize risk, consider non-recourse factoring, where the factoring company assumes the risk of non-payment due to customer insolvency. While this option may come with higher fees, it can provide valuable peace of mind.
6. Keep Detailed Records: Accurate record-keeping of all invoices, payments, and factoring transactions is crucial. This helps ensure transparency, simplifies reconciliation, and supports compliance with your factoring agreement.

By following these best practices, small business owners can utilize invoice factoring to enhance cash flow, foster stronger customer relationships, and achieve greater financial stability.

Common Factoring Mistakes to Avoid

While invoice factoring can be a powerful tool for improving cash flow, several common mistakes can undermine its effectiveness. Here’s what to watch out for:

1. Not Understanding Fees and Terms: Some business owners overlook the details of factoring fees, advance rates, and contract terms. This can lead to unexpected costs and cash flow issues. Always review the factoring agreement thoroughly and ask questions if anything is unclear.
2. Poor Customer Credit Checks: Since approval and risk are based on your customers’ creditworthiness, failing to assess customer credit can result in declined invoices or increased risk of non-payment, especially with recourse factoring. Ensure that you evaluate customer credit before factoring invoices.
3. Inadequate Record Keeping: Disorganized or incomplete records can cause disputes with the factoring company, delay cash advances, and create administrative headaches. Keep detailed, up-to-date records of all invoices and payments.
4. Over-reliance on Factoring: Relying on invoice factoring as a permanent solution can mask deeper cash flow issues within your business. Use factoring strategically, and work to address underlying problems such as slow-paying customers or inefficient billing processes.
5. Ignoring Alternative Financing Options: Failing to consider other business financing options, such as lines of credit or term loans, may result in missing out on more cost-effective solutions. Evaluate all available options to find the best fit for your needs.
6. Not Monitoring Factoring Company Performance: It’s essential to regularly assess your factoring company’s performance, including its collection practices and customer service. Poor practices can damage your customer relationships and your business’s reputation.

By avoiding these common mistakes, business owners can maximize the benefits of invoice factoring, minimize risks, and sustain a healthy cash flow for long-term success.

Is Factoring the same as Invoice Financing?

No, invoice factoring and invoice financing are two different structures. They share some similarities, and both methods convert receivables into cash. However, there are also some key differences.

Invoice financing is a loan that adds to a company’s debt. The business retains ownership of its accounts receivable and repays the loan by collecting payments from its customers.

Instead of a discount rate, invoice financing carries interest. The costs of the discount rate and interest rate are similar, though.

Invoice factoring is not a loan and doesn’t add to a company’s debt. It’s a sale of receivables, which is reflected in financial statements and taxes. Factoring does not add liabilities to the balance sheet, as the receivables are sold and considered off-balance-sheet assets.

The factoring company owns the receivables and collects payment from the selling company’s customers.

Can Small Businesses with Bad Credit Get Invoice Factoring?

Yes, it is possible to get approved for invoice factoring with a bad credit score. That’s one of the main advantages.

Since repayment comes from your customers paying their invoices, factoring companies scrutinize their credit more closely than yours. Some invoice factoring companies don’t have any credit score requirements. However, having a strong business credit history can still help you access a broader range of financing options and better terms, as it demonstrates your business’s financial credibility.

The companies that set a minimum credit score often set it low. For example, some factoring companies only require a minimum credit score of 550.

We should note that it’s an expensive form of business financing. Additionally, you cannot build or repair your credit using invoice factoring.

What are my other financing options?

Factoring is a form of working capital financing. If neither invoice factoring nor reverse factoring works for your business, there are several loan options to secure working capital.

Established businesses with excellent credit may consider a traditional bank loan. However, bank loans often come with stringent qualification requirements and lengthy funding times.

Other alternatives for improving cash flow include accounts receivable financing, which leverages unpaid invoices to provide quick access to funds.

Consider any of the following small business financing options:

• Working capital loans
• Equipment financing
• Merchant cash advance
• SBA loans
• Revenue based business loans
• Business lines of credit
• Business term loans

Small Business Factoring – Final Thoughts

Invoice factoring is ideal for small businesses that require an immediate influx of cash to cover their daily expenses. The rates are higher than those of other forms of business financing, but the cost is worth it if it enables the company to grow while maintaining its business.

Contact us to discuss invoice factoring for your small business. Our dedicated loan experts will go over the best financing options to meet your business needs.