Factoring is when a business buys your outstanding invoices and pays you the money immediately, for a small fee.
If you need money to cover your operating costs, this might be an option for you: You sell your outstanding invoices, and get the money that you are owed immediately. The factoring company, usually a financial institution or bank, takes a small fee for this service, usually a percentage of the invoice amount.
Factoring is similar to invoice sales, but they’re not the same. With factoring, businesses usually sign a contract for another company to cover all of their invoices. With invoice sales, you can sell individual invoices, at your discretion.
What are the benefits of factoring?
The main reason businesses use factoring is to improve their liquidity. It makes it possible for your business to cover operational expenses such as wage costs and supplier bills without waiting for customers to pay.
There are plenty of benefits, such as:
- Immediate cash. You get paid very quickly and can use that money to cover operating costs, start new projects or make new investments—or to cover unforeseen expenses.
- Better planning. When you sell your invoices in this way, it makes it easier to set up budgets and to maintain a healthy cash flow in your business.
- No follow-up. You don’t have to follow up with your clients to ensure that outstanding invoices are paid. The factoring company now owns the invoice, and they’re the ones who have to collect the money. This can save you a lot of time.
- No risk. If clients don’t pay, you still get paid.
But remember that the cost of the service will impact your profit. You might have to increase the price of your products or services, in order to reach your break-even point.
There might also be some criteria you have to meet before you can sign a factoring agreement.
What does it look like in practice?
Let’s take an example. You have a factoring contract, and you send an invoice to a client for $500. If the factoring fee is 2 percent of the invoice amount, you’ll get paid $490, and they’ll take $10.
Then the factoring company will have to follow up with your client to ensure that they pay the invoice.
