How Invoice
Factoring Works?
What
is the process, and what will my customers experience?
The
process will be different depending on which invoice factoring company
you work with. This section of our website will explain what happens
when invoices are factored, and it will also explain the variations
within the invoice factoring process.
STEP
1: Letting your invoice factoring company know about the
invoice and then sending it to your customer.
The
worst case scenario here is that you send the printed invoices to
your factor via Fedex; you pay overnight charges because you want
your money quickly; they stamp something on the invoice like "This
invoice has been sold to Factoring Company XYZ"; and then they
send it to your customer for you.
Yuck.
The
best case scenario here is that you send your invoice to your customer
as you do today (with no statement on the invoice that it has been
factored) and you let your invoice factoring company know about
the invoice via a few simple keystrokes into a website.
And,
of course, there are many variations of this first step of invoice
factoring. You have to find a process that you are comfortable with.
In the section on choosing an invoice factoring company we'll show
you how to find one that's right for you.
STEP
2: Your invoice factoring company communicates with your
customer to confirm the invoice.
This
step is typically not TOO bad. Your invoice factoring company will
call your customer, and they will often say something like "we're
calling on behalf of Company XYZ (that's your company) to confirm
invoice ABC". Ideally, they'll present themselves as a billing
facilitation service, making it pretty invisible to your customers
that you are using invoice factoring.
And,
by the way, once your invoice factoring company gets familiar with
you and your account, many of them stop confirming every invoice.
They'll do spot checks.
But…
there is one little catch.
The
vast majority of invoice factoring is done with what they call "full
customer notification." That means that they'll send a letter
to your customer saying that they have purchased your invoices and
that any payment by your customer to you (instead of to the invoice
factoring company) will not discharge your customer's obligation
to pay the invoice.
The
good news is that this step only happens once, and most of your
customers will quickly forget about the letter. The bad news is
that it happens at all, and that it happens with the vast majority
of invoice factoring companies. If it is really important to you
that your customer not receive such a notification, you might not
find an invoice factoring company willing to do it that way (but,
never say never, we know of at least one that can accommodate you,
which we'll briefly mention in the section on picking from the invoice
factoring companies.) And, we'll show you how to get information
about other such invoice factoring companies.
STEP
3: You get cash for your invoice within a few days of submitting
it to your invoice factoring company.
This
is the best part. After your invoice is confirmed by the invoice
factoring company, they'll direct deposit the funds (electronically)
into your bank account within a couple of business days. (OK, there
are some factors that send funds electronically only once a week
or they'll send you a paper check for the funds, but the practice
of most of them is to send funds electronically right after the
invoice is confirmed.)
So,
the questions at the top of your mind should be: how much of that
invoice do I get…and how fast?
Invoice
factoring is typically done by paying you a portion of the invoice
upon confirmation by your customer, and that portion is called the
"advance." The rest of the invoice is not paid to you
immediately. That is called the "holdback" or "reserve."
When your customer pays the invoice factoring company, you'll get
paid the remainder of this holdback/reserve.
Typically,
an invoice factor will "advance" 70% to 85% of the total
invoice amount.
If
you find an invoice factoring company that goes significantly lower
than that, you can probably do better. If you find one that goes
higher, congratulate yourself.
How
important is this to you in selecting an invoice factoring company?
It boils down to how much cash flow you need to pay your suppliers
or employees. The more you need, the more important this percentage
(often called the "advance rate") is.
Now,
you might also ask "how fast" you will get that advance.
In most cases, you'll get the funds a couple of business days after
the invoice is confirmed, give or take a day. If you hear something
different, it should be a consideration in your decision.
CAUTION:
If you need funds PRIOR to issuing your invoice, you are now talking
about purchase order funding, not invoice factoring. It is extremely
difficult to get qualified for purchase order funding, and the costs
are very high (think in terms of 5% to 15% of the invoice amount.)
Our advice to businesses that want purchase order funding is always
the same: "Try, try, try to find some other way to get some
extra cash flow…at least until you can issue the invoice and
get it confirmed." Not exactly what you wanted to hear, but
why waste your time with a lengthy application process that results
in you getting turned down?
STEP
4: Your invoice factoring company calls your customer
to collect.
Scary,
isn't it.
You
can just imagine the following conversation: "Look pal, either
you pay this invoice, or we're going to sue you so fast, it will
make your head spin."
Well,
the good news is that your invoice factoring company really has
strong incentive not to do this. First, it rarely works. The best
collections work is done with calm and friendly persistence…
not threats. Second, it is much better for them to get YOU involved
if collection is necessary. You have the customer relationship.
You'll be much better at convincing your customer to send the check.
Third, your invoice factoring company doesn't want to lose you as
a customer…and they would if they lost an account for you.
Guaranteed.
All
that said, if this process makes you too uncomfortable, you can
find invoice factoring companies that do not engage in collections
work, though they are rare. In the section on finding an invoice
factoring company, we'll show you how to ask about this.
STEP
5: Your customer sends their check in payment of your invoice
Unfortunately,
that check won't be sent to you.
The
check will be sent to your invoice factoring company's lockbox.
Now, that is not necessarily a bad thing. After all, it is more
secure than checks going to your business. The funds get deposited
immediately. Often, these lockboxes are set up near post offices
that receive mail fast from all parts of the country, so the process
of getting the check from your customer to the lockbox can be quite
fast.
And,
yet, it would be easier for you if you didn't have to tell your
customers to change their remit-to address. We've looked for a long
time, and we haven't found invoice factoring companies that allow
the checks to be sent to your business. If you know of one, please
have them email
us.
However,
there is one thing that you might want to look for carefully in
selecting an invoice factoring company: Who is the check made out
to?
Most
invoice factoring companies insist that the check be made out to
them. Some will allow the check to be made out to Your Company Name
c/o Invoice Factoring Company Name. And, some will allow the check
to be made out to you. One thing is clear, though. Some of your
customers will be much more comfortable changing the remit-to address
than they will be changing the payee. So, if you can find an invoice
factoring company that doesn't require you to change that payee
name, it is probably a good thing. In the section on choosing among
the invoice factoring companies, we'll remind you to ask this question.
STEP
6: Your invoice factoring company receives the check from
your customer and remits funds to you.
This
is pretty straightforward: Your invoice factoring company receives
a check; they deduct their fees; they direct deposit the difference
in your bank account with a business day or two. (Some invoice factoring
companies will wait to deposit the difference…and they'll do
so weekly or something like that. In the section on picking an invoice
factoring company, we'll remind you to ask this question.)
THE
FINAL STEP…which you hope never happens.
OK.
What if your customer never pays? Are you responsible, or is your
invoice factoring company?
You
want to know what most invoice factoring companies will tell you?
"We are a non-recourse factor". They'll say that this
means that if the invoice isn't paid, you aren't responsible, except
in certain circumstances.
Well,
guess what. Those "certain circumstances" happen quite
often. In fact, if your customer hasn't paid, most of the time those
"certain circumstances" do apply. So, you'll be happiest
if you just assume that you are responsible if your customer doesn't
pay. (And, by the way, when we say "you", we mean you
the owner, personally, not your company.) We'll go into this in
more detail in the section on pricing and terms for account receivable
factoring.
Now,
you are an expert
We'll,
perhaps not. But you know a ton more than most people. Please review
the other sections of this website to become a real pro:
How
expensive is account receivable factoring?, and what other
terms should I pay close attention to?
What
is the best way to select a factoring company? How do I
avoid the time consuming process of winnowing through all the factoring
companies out there, yet still get the best terms for my business?
How
do I know if I'll qualify for a factoring service? How do
I avoid spending a lot of time on this only to find out that nobody
will help me?
"Remember
that our site uses much of the industry terminology interchangeably.
Words such as Factoring
Companies, Invoice
Factoring, Factoring
Service all
reference the topic of this site, and you can click on any of those
phrases to go to the home page of our site."
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