A factoring discount is the percentage of the invoice that is discounted when the factor buys the invoice from you. This percentage can be negotiated, and it depends on a number of factors, including how long it will take for the factor to recoup its investment in the invoice. Generally, though, you can expect a factoring discount of anywhere from 1% to 10%, which can be a great return on investment, assuming the cash flow of the business can support paying. Keep in mind, though, that not all invoices qualify for discounts; factors generally only offer discounts on invoices that are due within 30 to 60 days. So if you have an invoice that’s due in 90 days or more, you may not be eligible for a discount. But it’s always worth asking!
Invoice Factoring Explained
Invoice factoring is a type of financing that companies can use to get working capital quickly, often to pay short-term bills such as payroll. It works by allowing a company to sell its accounts receivable (invoices) to a third party, called a factor, in exchange for cash. The factor then collects the money from the customers who owe the company money. This can be a helpful option for companies that need to get fast cash to cover expenses, but don’t want to take out a loan or sell equity.
One thing to note is that invoice factoring can be expensive. The factoring company will usually charge a fee (called a discount rate) for purchasing the invoices, as well as an interest rate on the money that it lends to the company. Additionally, the factor will take a percentage of the money that it collects from the customers (called a factoring fee). This can add up to a significant cost, so companies should weigh the costs and benefits of invoice factoring before deciding if it’s right for them.
What Are The Different Types Of Factoring?
Factoring is a type of financing where a business sells its accounts receivable (invoices) to a third party, called a factor, at a discount. The factor then becomes the primary creditor for those unpaid invoices. There are various types of factoring options available to businesses, which can be confusing to navigate. Here’s a breakdown of the most common types:
1. Invoice factoring: Invoice factoring (also called invoice financing) is the most common type of factoring. In this arrangement, the business sells its accounts receivable to the factor for a percentage of the transaction value. The factor then becomes the primary creditor for those outstanding invoices. This type of factoring is best suited for businesses that have a steady stream of invoices and need quick access to cash.
2. Accounts receivable financing: Accounts receivable financing is similar to invoice factoring, but the factor doesn’t take possession of the invoices. Instead, the business retains control of its accounts receivable and simply borrows money from the factor based on the value of those invoices. This type of factoring is best suited for businesses that need a longer-term loan and have a good credit history.
3. Purchase order financing: Purchase order financing is a type of factoring where the factor pays for goods or services when they are ordered, but not yet paid for. This type of factoring is best suited for businesses that need to finance the purchase of inventory or other assets.
4. Line of credit factoring: Line of credit factoring is a type of factoring where the factor extends a line of credit to the business. The business can then draw on this line of credit as needed to finance its accounts receivable. This type of factoring is best suited for businesses that have a good credit history and need access to capital on a short-term basis.
5. Debt factoring: Debt factoring is a type of factoring where the factor purchases the business’s existing debt. This type of factoring is best suited for businesses that need to get out of debt or need cash to pay down their debt
Choosing the right type of factoring can be confusing and credit terms aren’t often as good as a traditional financial institution, so it’s important to consult with a factor who can help you navigate the options.
Also see: What is asset financing?
What Are The Differences Between Invoice Factoring And Invoice Discounting?
There are several key differences between invoice factoring and invoice discounting. The first is that factoring entails the selling of invoices to a third party, while discounting does not. Secondly, factoring typically involves a longer repayment period than discounting. Finally, factoring rates are typically higher than discounting rates.
Why Use Factoring Instead Of A Bank?
Sometimes, either due to a lack of collateral, poor credit score, or the length of time to obtain a bank loan, factoring can be a better option for a small business owner.