Factoring Business 101 | huge strength in Supply Chain

Many small businesses suffer from cash flow problems when customers are late in paying their invoices. The best factoring companies, also called factors, help out other businesses. They do this by giving them the money they need now, so small companies can pay employees, suppliers, and other expenses.

By using factoring businesses, a smaller business can increase their cash flow while waiting for customers to pay off their balances. Instead of waiting until the customer’s invoice is due, a business can have the cash advance, and then the customer will pay back the factoring business in full.

While a loan requires repayment whether the customer pays their balance or not, the invoice factoring company does not carry that risk for the smaller business.

What is Factoring

accounts receivable factoring

Factoring is a way that businesses can quickly acquire funds based on projected future income. A financial company gives money to a business based on outstanding invoices billed to creditworthy customers, so the invoice factoring company knows the business is good for the money they are receiving.

Without using the best factoring company, you would have to wait one to three months for your customers to pay. Factoring gives the business the funds needed to pay rent, suppliers, employees, and any other bills they need to pay before the invoice is due.

Since the factoring business bought the invoice, the customer then pays that company back in full. Although factoring or accounts receivable financing carries the same name, this is nothing like a bank loan. The factoring company purchases the invoices from a business flat-out. The full amount of the invoice is more than the factor paid. This is how the factoring company makes money.

For example, if the business sent a customer a $50,000 invoice, the factor might buy that invoice for $45,000. This benefits the smaller business because they have $30,000 of bills and payroll due next week. Eventually, the customer pays the factoring company the $50,000 owed. When that happens, the factoring providers pay themselves back and keep a portion of the rest for factoring fees. Finally, they a percentage back to the original business.

Many businesses prefer to work with a factoring company instead of taking out a bank loan since they carry less risk. Factoring involves an outright purchase of invoices. With this model, the business does not incur any debt, as they would with a loan. Factoring invoices also does not affect your credit score.

How Does Factoring Companies Work?

Factoring helps money flow into a business when they need to pay their expenses. Instead of waiting for customers to pay invoices, service-based businesses can get 90% of the unpaid invoices. Product-based businesses can get 80% of the outstanding invoice. The remaining percent of the invoice is given back to the company after the customer pays the factor.

When a business uses a factoring company, the factor will pay the corporation an advance of up to 90% of the invoice value. The factoring company collects the customer’s full payment and returns 10% to the business while taking a factoring fee. The factoring fee usually is between 1% and 5% depending on factors like:

  • total amount of the invoice
  • length of the payment term
  • customer’s credit score

Factoring Flow Chart

Need more insight on how a business can use a factoring company? First, it’s essential to understand the process flow.

Step One

The company conducts business, offering services or products to customers, as usual. The invoice needs to be paid within thirty to ninety days, but the company can’t hope for customer payments to arrive. The original business contacts a factoring company to buy the unpaid invoices from them.

Step Two

Before buying the unpaid invoices, the factoring company runs background checks and credit checks. They want to make sure that the original customer is likely to pay back their invoice in full. If the factor finds the customer satisfactory, they’ll send a contract to the original business specifying the guidelines. The business then sends the factoring company the customer’s invoice.

Step Three

The business reviews financial statements and signs the contract, and the factor receives the invoice. Then, the money goes to the original business. From that point, the customer will pay back the factoring company instead of the original business.

Step Four

The factor takes a portion of the customer’s payment as their fee and this is how they make money. They give a certain percentage back to the original business, as outlined in the signed contract. The original company can then factor other invoices. A perk of invoice financing is that it does not damage credit or financial standing the way loans can.

Types of Factoring

There are two types of factoring: recourse and non-recourse, with one major difference that sets them apart.

Recourse Factoring

Recourse factoring is the most commonly used type of factoring. The factor buys the invoice from the business and grants them a certain percentage of the total, usually 80 or 90%. The customer pays in full directly to the factor. Then, the factor takes its fees and pays the remainder back to the business.

In recourse factoring, if the customer does not pay the factor before the invoice is due, then the original business must repay the 80 or 90% originally given to them, plus any fees. The responsibility to collect from the customer reverts to the original business, and ties between the business and the factoring company are severed.

Non-recourse Factoring

Non-recourse factoring is similar to recourse factoring in that the invoice is sold for 80 or 90%. In this case, the customer is then supposed to pay the factoring business directly. However, if the customer does not pay the invoice for legal reasons, the business keeps the advance percentage, and the factoring company takes the loss.

This type of factoring keeps the small business safe, especially during uncertain economic times when companies are often declaring bankruptcy. However, non-recourse factoring isn’t available everywhere.

Scope of Factoring Businesses

accounts receivable

Banks might offer factoring services, but most factoring companies are separate institutions. To best serve their market, factoring companies tend to focus on specific industries, like:

  • Accounts receivable financing
  • Transportation factoring
  • Government invoice factoring
  • Purchase order factoring
  • Medical billing factoring
  • Factoring in banking
  • Credit card factoring
  • Small business factoring
  • Freight bill factoring
  • Factoring broker training
  • Freight brokers
  • Trucking invoice factoring for trucking companies

Best Factoring Companies for Truckers and Freight Brokers in USA

This list highlights the five best factoring businesses for truckers and freight brokers, which offer fuel advances, along with other trucker-centric perks.

eCapital

The highly-rated Accutrac Capital recently merged with eCapital to make a powerful factoring company. eCapital offers both recourse and non-recourse factoring. Neither option has a minimum invoice amount.

Thunder Funding

Thunder Funding started with truckers frustrated with delayed payments. They have an insider’s perspective of the trucking industry and offer non-recourse factoring with quick turnaround times.

Apex Capital

Apex Capital is one of the most established factoring companies in the trucking industry. They offer both recourse and non-recourse factoring. Customers also say they have excellent customer service. The invoice financing company is perfect for those who are new to the factoring process and need help understanding it.

Triumph Business Capital

Triumph has been in operation for over sixteen years and has rave reviews from its customers. They offer both recourse and non-recourse factors, with a 100% advance rate. Users can join Triumph’s referral program to earn bonuses when they bring new customers on board.

TBS Factoring

TBS Factoring offers both recourse and non-recourse factoring, and they distribute 100% advances! This comes at a higher fee, which is to be expected, but not withholding an advance can be more beneficial for those in dire straits.

Average Cost of Factoring Charges

debt factoring

The average cost of factoring can vary depending on what rate you have and what fees the factor charges. Factoring companies charge flat or monthly fees. Monthly fees are usually more affordable than weekly fees. Different factoring companies charge different rates, so it’s worth researching.

Tiered Factoring Fee

The most common fee is the tiered factoring fee that charges fees daily, weekly, or monthly. The quicker the customer pays, the more money the original business will get back. This example uses a $10,000 invoice with a 90% advance. The factoring company charges a 1.8% fee per month. The days are counted by fives for efficiency only.

 Option A – 30-day BasisOption B – Daily Basis
Day One$180$6
Day Five$180$30
Day Ten$180$60
Day Fifteen$180$90
Day Twenty$180$120
Day Twenty-Five$180$150
Day Thirty$180$180
Day Thirty-Five$360$210
Day Forty$360$240
Day Forty-Five$360$270
Day Fifty$360$300
Day Fifty-Five$360$330
Day Sixty$360$360

The daily fee option benefits the original business if the customer pays their invoice quickly. If they wait until thirty or sixty days, the fees even out. It’s important to consider the benefits of a daily fee schedule if the business knows how quickly their customers are likely to pay.

Flat Fee

Factoring companies that charge a flat fee will take the same amount from the final repayment no matter when they pay it back. Consider the previous example of a $10,000 invoice with a 90% advance rate, but with a 4% flat fee. At a 4% fee, the factoring company will take $400 whether the customer pays on day one or day 60.

Flat fee options are best for businesses that need to know how much money they’re getting back from the invoice repayment. The original company will receive $600 no matter when the customer pays.

Factoring Software Solution

Different software solutions are available for factoring companies. The software keeps track of invoices and contracts and has automated collection reminders. It streamlines the process by connecting the factoring company with the small businesses they help. The software installs directly onto office computers for easy use. But you can also access it via the cloud from any authorized device.

Disadvantages of Factoring in Business

Since factoring is not a loan, it’s easy to see the benefits of using it in business. However, there are some disadvantages of factoring to consider. The biggest concern is that the fee paid to a factoring company will result in a smaller profit margin on each service fulfilled or product sold.

Once the business sells invoices to a factoring company, the customer pays back the factor instead of the original business. Many customers may prefer to keep dealing with the initial business, so this could be a deterrent.

International Factoring Association

The International Factoring Association offers membership to any bank or financial institution that provides factoring services. The organization has training and certification opportunities for members and requires them to follow a Code of Ethics.

The website also offers FactorSearch, which helps businesses find quality factors to help with their immediate cash flow problems. Using a factoring company that is a member of the International Factoring Association shows businesses that the factor values its reputation and holds itself to a high professional standard.

How To Start a Factoring Business Company

companies factor

After learning how factoring works, you might want to start your own factoring business company. There are some crucial steps to take to get your company off the ground.

Plan

To start your own factoring business, you need to have a detailed business plan, listing things like what industry you will provide factoring facility for and how broad your company will reach.

Determine Geographic Location

Your geographic location will impact whom you provide invoice financing services: a specific state, a broader region, or a wider online audience?

Understand Market Size

If you’re supplying factors for a certain industry, you’ll need to research that market to see how large it is. This will impact the potential success of your company.

Source the Funding

How will you provide the advances for factoring? You’ll need to find backers who can invest in your company or meet with your financial planners to secure funding.

Hire Skilled Workers

You’ll need to hire people who are familiar with finances, as well as people who know the industry you’re serving. Good workers mean happy customers!

Factoring Broker Training

Send your brokers for factoring broker training. The International Factoring Association offers this service. With such an affiliation, your business might seem more credible.

Marketing

Spread the word about your business! Target the specific industry to which you’re providing the service.

Use Software

Factoring software can streamline your financial records and be used for reporting, invoice tracking, collections, and growth calculation.

Wrap Up

Now that you have the background information about factoring and tips to start your own company, you can launch a high-quality factoring business.

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