As a small-business owner, you can turn your unpaid customer invoices into fast cash with invoice factoring and its closely related counterpart, invoice financing. It’s best for business owners whose customers don’t pay for goods or services until a later date but who need cash now to run their business.
Here’s what you need to know about invoice factoring and invoice financing, plus some options on where to find financing.
What is invoice factoring?
Technically, invoice factoring is not a loan. Rather, you sell your invoices at a discount to a factoring company in exchange for a lump sum of cash. The factoring company then owns the invoices and gets paid when it collects from your customers, typically in 30 to 90 days.
Let’s say you own a hardware store and sell goods to another business, creating a $10,000 invoice. Your customer agrees to pay off its invoices in 30 days, but you need the cash next week to pay your employees. You’ve got a cash shortfall.
You could turn to a traditional bank for a loan, but it likely would require stellar personal credit plus collateral, a physical asset such as real estate that the lender could sell if you default. Or maybe you qualify but can’t wait several months for the loan to close.
So you turn to an invoice factoring company, and it agrees to buy your invoice for $9,700 in cash — $10,000 minus a 3% factoring fee ($300). The invoice factoring company advances 85% (or $8,245) of the invoice within a few days. The factoring company then collects the invoice when it’s due and provides the remaining balance owed to you ($1,455).
Invoice factoring example
|Initial advance (85% of invoice value after fee)||$8,245|
|Remaining advance (12%)||$1,455|
The factoring fee, also known as the discount rate, can run from 1% to 5%, depending on the invoice amount, your sales volume, your customer’s creditworthiness and whether it’s a recourse or nonrecourse factor. The factor type refers to who is ultimately responsible for an invoice that goes unpaid — your company or the factoring company.
If the contract is a recourse factor and the customer doesn’t pay, you may have to buy back the unpaid receivable from the factoring company or replace it with a more current receivable of equal or greater value. If it’s a nonrecourse factor, you’re under no obligation to repay or replace the unpaid receivables, but you’ll likely be charged a higher transaction fee because the factoring company takes on the added risk of not getting its money back.
Invoice factoring pros and cons
- Fast cash: Invoice factoring can provide immediate working capital to help cover a funding gap caused by slow-paying customers.
- Improved cash flow: You can keep loyal customers on longer payment terms but still improve your cash flow to help you grow your business.
- Easier approval: Invoice factoring provides financing to companies that might not be able to get capital from other sources, such as a traditional bank, because of a lack of collateral to back a loan, poor personal credit or a limited operating history. Typically, factoring companies care only about the value of the invoices you’re looking to factor and the creditworthiness of your customers.
- High cost: The service can be expensive. You also have to watch out for hidden fees, such as application fees, processing fees for each invoice you finance, credit check fees or late fees if your client is past due on a payment. Late payments can trigger an increase in your annual percentage rate, the annual cost of borrowing money with all fees and interest included.
- Loss of direct control: Because the invoice factoring company may collect on the invoices directly, you need to make sure it’s ethical and fair when dealing with your customers.
- Customers’ bad credit could derail your financing: The factoring company may need to verify the creditworthiness of your customers. If the customers have a history of late or missed payments, you may not be approved for the financing.
Invoice factoring and financing options
Invoice financing is a bit different from factoring. You don’t sell your invoices to a factoring company; instead, you use the invoices as collateral to get a cash advance and are responsible for collecting payment on the invoices yourself.
If you’re looking for invoice factoring or financing, we compare online options below. Terms, rates, speed of funding and qualifications differ for each lender.
BlueVine offers invoice factoring. The company advances 85% of your invoice amount upfront and the rest when a customer pays you — which can be anywhere from one to 12 weeks after the initial advance — minus fees of 1% per week.
BlueVine’s APRs on invoice factoring range from 17% to 60%. It’s a good option if you need to finance a large amount of invoices because the company lends up to $2 million. To qualify, you’ll need a minimum credit score of 530, plus at least three months in business and $10,000 in monthly revenue, for a minimum annual revenue of $120,000. BlueVine requires you to set up a new bank account and a post office box for your customers’ payments.
- Loan amount: $20,000 to $2 million
- APR: 17% to 60%
- Loan term: One to 12 weeks
- Funding time: One to three days
- Read our BlueVine review
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Fundbox is an invoice financing company that advances 100% of the value of the invoice upfront, and you repay it in 12 or 24 equal weekly installments, plus a fee. You can borrow from $1,000 to $100,000, with funding in one to three business days. APRs range from 16.4% to 76.5%. You can repay the loan early to save on fees, which lowers the APR.
Fundbox is a good option if you have bad credit or want to avoid a credit check, or if you need to finance a smaller amount from your invoices. No minimum credit score, time in business or revenue is required, but you’ll need at least six months of activity in online accounting or bookkeeping software that’s compatible with Fundbox, such as Quickbooks or Freshbooks.
- Loan amount: $1,000 to $100,000
- APR: 16.4% to 67.7% for 12 weeks; 18.5% to 76.5% for 24 weeks
- Loan term: Equal repayments over 12 or 24 weeks
- Funding time: One to three business days
- Read our Fundbox review
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Find and compare the best small-business loans
If invoice factoring or financing is not for you, check out other financing options on NerdWallet’s small-business loans page. We gauged lender trustworthiness, market scope and user experience, among other factors, and arranged them by categories that include your revenue and how long you’ve been in business.
Updated Feb. 6, 2017.