Financial Glossary
Invoice factoring
Invoice factoring is a form of receivables financing in which a business sells its outstanding invoices to a third-party factor at a discount in exchange for immediate cash. The factor advances a percentage of the invoice face value -- typically 70-90% -- upfront, then collects the full amount from the business's customer and remits the remainder minus a factoring fee. Factoring differs from a bank line of credit: the factor takes on the collection risk (in non-recourse factoring) or returns unpaid invoices to the business (in recourse factoring). Fees are typically expressed as a percentage of invoice value per 30-day period outstanding.
Problem & Application
A campground landscaping contractor completes a $50,000 job for a large resort operator but faces a 60-day payment term. Waiting 60 days strains payroll. The contractor factors the invoice: the factor advances 85% ($42,500) immediately. After 60 days the resort pays the factor $50,000. The factor deducts a 3% fee ($1,500) and remits the remaining $6,000 to the contractor. Total cost: $1,500 on a $50,000 invoice, or effectively about 9% annualized for a 60-day advance. This is expensive relative to a bank line of credit but accessible to businesses without the credit history or collateral to qualify for bank financing. Businesses should compare the annualized factoring cost against the cost of missing payroll or losing a vendor discount for early payment.
In Short
Invoice factoring is a useful option for businesses needing immediate cash flow but should be considered carefully to weigh the cost against the benefits.