Definition
Invoice factoring is a form of financing in which a business sells its unpaid invoices to a factoring company for an immediate cash advance, typically most of the invoice value. The factor collects payment from the client and pays the remainder to the business, minus a fee. It turns slow-paying receivables into cash quickly.
Also called: Factoring, Accounts receivable factoring, Invoice financing, Invoice discounting, Invoice finance, Debtor finance
Invoice factoring in practice
A typical arrangement advances 70 to 90 percent of the invoice value upfront. When the client pays, the factor releases the balance minus its fee, which is often a few percent of the invoice per month outstanding.
With recourse factoring, the business must buy back invoices the client does not pay. With non-recourse factoring, the factor absorbs some or all of the credit risk, at a higher fee.
Invoice discounting, or invoice financing, is a related option where the business borrows against its invoices but keeps collecting from clients itself, so clients may not know financing is involved.
Example
A trucking company factors a $10,000 invoice on Net 60 terms. It receives $9,000 the next day. When the shipper pays 50 days later, the factor sends the remaining $1,000 minus a $300 fee.
Frequently Asked Questions
Will my client know I am factoring invoices?
Usually yes with factoring, because the client is told to pay the factor directly. With invoice discounting, the business collects as normal and the arrangement is typically confidential.
Is invoice factoring a loan?
Strictly, factoring is a sale of receivables rather than a loan, though recourse factoring behaves much like secured lending. Invoice discounting is usually structured as a loan.
Related terms
- Accounts receivable Accounts receivable is the total amount of money owed to a business by its clients for invoices that have been issued but not yet paid.
- Cash flow Cash flow is the movement of money into and out of a business over a period.
- Net 90 Net 90 is a payment term meaning the full invoice amount is due 90 calendar days after the invoice date.
- Days sales outstanding Days sales outstanding (DSO) measures the average number of days it takes a business to collect payment after a sale is invoiced.
- Bad debt Bad debt is an invoice amount that a business concludes it will not be able to collect, usually because the client has gone out of business, disappeared, or refuses to pay and legal action is not worthwhile.
This page is for general information only and is not legal, tax, or financial advice. Rules change and vary by location, so consult a qualified lawyer or accountant about your situation.