Invoice factoring - or invoice financing - involves a third-party factor buying a company's unpaid invoices to help it free up cash.
However, factoring involves much beyond this basic definition and Stenn has produced this guide to give you important information to consider.
How Do Invoice Factoring Companies Work?
Suppliers (Exporters) often sell goods to their Buyers (Importers) on deferred payment terms, which means they may have to wait up to 120 days for payment. This can lead to cash flow problems - when wages and other running costs need to be paid - as well as an inability to invest in company growth.
Invoice financing companies bridge this cash flow gap by buying invoices from the Supplier in exchange for liquid capital once goods are shipped. The finance company then collects payment from the Buyer when the invoice is due.
The financier advances a percentage (usually 70-90%) of an outstanding invoice to the Exporter, with the balance (minus a pre-agreed fee) sent once the Importer has paid the invoice.
Invoice Factoring Process
An Exporter invoices an Importer for products or services with delayed payment terms.
The factoring company now advances a percentage of the value of the invoice directly to the Exporter.
The factoring company then waits for the invoice to be paid on the due date.
When the invoice is paid, the factoring company sends the balance payment (minus a pre-agreed service fee) to the Exporter.
If the Importer doesn't pay the full invoice amount, liability for the invoice payment depends on the type of invoice finance requested. In non-recourse financing, the finance company assumes liability for the loss, whereas, in recourse financing, the Exporter would be responsible for chasing the Importer for payment.
Invoice Factoring Example
Supplier Ltd owns $1 000 000 (USD) of unpaid invoices for goods shipped to Buyer Ltd on 120-day terms but needs access to cash now.
A factoring company (Stenn) agrees to advance 90% of their face value ($900 000 (USD)) to Supplier Ltd.
Buyer Ltd later pays the $1 000 000 (USD) invoice amount to Stenn on the agreed date.
Stenn then pays the remaining 10% ($100 000 (USD)) to Supplier Ltd, minus a service fee.
For more information on invoice financing and how it works, check out our walkthrough video:
Which Companies Can Use Factoring?
Businesses in any industry can use invoice factoring. However, the service significantly benefits companies in sectors that trade using deferred payment terms. These typically include:
Food and beverages
How Much Does Invoice Factoring Cost?
Invoice factoring costs are typically charged as a percentage of the invoice amount.
For example, if a factoring company charged a 1% fee for an invoice sum of $100 000 (USD), it would take $1 000 (USD) from the final invoice amount.
Other factors can influence the cost of invoice financing services. These include:
The invoice amount - the higher the cost, the greater the risk for the financier.
The length of payment terms - longer payment terms often result in higher fees.
Buyer quality - financiers may charge higher fees to protect themselves from risky Buyers.
Invoice factoring is not like a bank loan because Suppliers are receiving only the money that is already owed to them by their Buyers. They receive most of the money as an advance when goods are shipped, and the balance later.
An invoice factoring company provides instant cash to small businesses that need to cover short-term business expenses and can't wait for invoices to be settled. Many Exporters offer deferred payment terms to attract larger international Buyers, so invoice factoring can provide Exporters with access to cash that would otherwise be tied up for months in unpaid invoices.
Applying for invoice factoring can be more convenient and time-efficient than applying for a bank loan. Banks are often unwilling to assume the risk of lending to small businesses engaged in international trade. SME Exporters are more likely to be approved for invoice financing than for a bank loan, particularly if they are new firms or have patchy credit histories.
How to Choose the Right Factoring Company
If you're looking for a factoring company to finance your invoices, it's important to ensure it is the right company for your firm. Consider the following when reviewing firms:
An understanding of your industry.
Experience working with multiple exporting companies of a similar size.
Credit limits that meet your needs.
Provision of non-recourse financing.
No maximum number of invoices submitted.
Flexible - will finance one invoice or a whole ledger.
High percentage of cash advanced upon shipment of goods.
Easy and quick application process.
An excellent reputation.
Using the above criteria will ensure that you find an invoice factoring provider that's right for you.
Invoice Factoring FAQs
Are factoring companies safe?
Invoice factoring is among the safest and most convenient solutions for cross-border trade deals.
However, as with any financial agreement, business owners are always advised to carry out due diligence before working with any service provider.
Does the factoring company need to be local?
No. Many factoring companies offer an online service nowadays.
Stenn specialises in cross-border finance, working with Suppliers and Buyers that operate in different countries and arrange their financing via our online platform.
What is forfaiting?
Forfaiting is an example of 'non-recourse financing' in which the finance provider (the forfaiter) assumes the risk associated with non-payment by the Importer.
Can invoices be factored selectively?
Selective invoice factoring - or spot factoring - is when a Supplier chooses specific invoices to factor rather than selling all of its unpaid invoices.
This allows Suppliers to increase their cash flow with capital advances without incurring fees based on their whole ledger.
What is reverse factoring?
Reverse invoice factoring involves a Buyer using a factoring company to pay its Supplier's invoice, giving the Buyer more time to pay the invoice at a later date.
Reverse factoring benefits all parties by freeing up capital for the Buyer and Supplier, with the factoring company taking a service fee.
If you are interested in learning more about the content listed above, Stenn has a dedicated FAQ section where you can find more information about our invoice financing services. We also provide videos which explain the company and the financing process in detail.
About the Authors
This article is authored by the Stenn research team and is part of our educational series.
Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.
Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.
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Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. It is for information only and doesn't constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.