The Factoring Process: Step-by-Step 

The Factoring Process: Step-by-Step

Late customer payments can put your company in a cash flow crisis. Many businesses use invoice factoring to manage their short-term financing needs and pay for business expenses. A recent study found that the global factoring industry increased by 12.6% in 2021, demonstrating the growing demand for this financing solution. 

In the process of factoring, businesses sell their slow-paying invoices — or accounts receivable — to a third-party factoring company. This company immediately pays most of the invoice amount and assumes the responsibility of collecting the full invoice amount from the customer. 

Companies considering contracting with a factor should first understand the factoring process flow and the steps it requires. Learning how factoring process works and what steps to take can help you decide whether the process would be beneficial for your business. Here’s a step-by-step overview of how invoice factoring works:

1. The Business Sells to Customers

In the first step of the invoice factoring process, businesses sell their goods or services and invoice customers for the final cost. Your business must have accounts receivable to sell to a factoring company — also known as a factor — before you can complete the rest of the process. 

2. The Business Chooses a Factoring Company 

Using invoice factoring involves choosing a third-party factoring company to purchase invoices and collect payments. Selecting a trustworthy and reputable factoring company is an essential step in the process of factoring. While there are many factoring companies in operation, they may not all provide the reliability and expertise your business needs. Understanding how factoring companies work is vital for choosing one that suits your needs. 

Factoring companies provide several services besides immediate financing for your business needs. Once a factor receives your business’s accounts receivable, it takes ownership of your invoices. The factor becomes responsible for collecting customer payments, enabling your business to spend time on more valuable tasks. A factoring company may also manage your company’s sales ledger. 

Here are a few essential elements to consider and tips for how to choose a factoring company

  • Look for experience in your industry: Many factors specialize in specific industries like transportation, construction or health care. A factoring company with several years of experience within your industry will understand your company’s needs and be able to provide valuable expertise. 
  • Prioritize customer service: Since factoring companies provide an ongoing service, they frequently need to communicate with their clients. Select a factor that offers prompt customer service and personalized attention. 
  • Compare rates and fees: Factoring companies charge varying factoring rates and may include fees that apply in different situations. For example, a factor may charge an extra fee if your business doesn’t meet a monthly invoice minimum. Look for a factoring company with terms that suit your business’s typical output.
The Parties Enter a Factoring Agreement

3. The Parties Enter a Factoring Agreement

The next step in the invoice factoring process is to enter a factoring agreement and set up an account with the factoring company. A factoring agreement is a contract outlining the terms of the business relationship and providing details about when and how the factoring company will buy your invoices. Setting up an account with a factoring company is a one-time step that might take a couple of days.

Businesses must usually provide several documents before entering a factoring agreement, including business identification information, an accounts receivable aging report and a factoring application. Individual factoring companies have distinct application processes and may require different documents. 

After the application process, your business will work with the factoring company to create a factoring agreement. Consider the following elements before signing a contract: 

  • Any fees and when your business must pay: Some factoring companies require fees if their clients end a contract early or don’t provide a specific number of invoices per month. 
  • Contract length and rates: Your business might have different contract length and payment needs. If your sales and income are variable, you may prefer the flexibility of a monthly pricing structure to a one-time yearly fee. 
  • Whether the factoring is recourse or non-recourse: Recourse factoring is an agreement in which your business must repurchase unpaid invoices if a customer fails to pay. Non-recourse factoring requires the factor to absorb the costs of any outstanding invoices. 

The factoring agreement also dictates whether the invoices must be late or if a company can sell invoices that are not yet due. Depending on the type of factoring your company and the factor agree on, your business may receive payment for invoices around the invoice’s maturity date. 

4. The Business Sells Its Invoices

After your business signs the factoring agreement and sets up an account with the factoring company, it selects invoices to sell. The factoring company will then conduct due diligence to verify that the invoices are valid and whether the customers you want to factor have good credit. 

Once the factoring company agrees to purchase responsibility for your invoices, it sends a proposal to buy them from your business. The proposal may include the advance rate, factoring rate and length of the term. Factoring companies usually advance a significant percentage of the total invoice amount, often between 75% and 95%. However, this amount may vary and depends on the factoring agreement. 

Your business then signs the proposal, sends its invoices to the factoring company and receives immediate cash. 

5. The Factoring Company Invoices Customers

At this point in the invoice factoring process, the factoring company becomes responsible for pursuing customer payment. The factoring company may wait for the customer to pay their invoice or reach out to customers if their payment is late. 

The factor might need to alert the customer that they should pay the factor instead of your business. Depending on your factoring agreement, factoring companies may also become responsible for invoicing customers for the goods or services they buy from your company. 

6. The Transaction Is Settled 

The final step in the invoices factoring process is invoice payment. In a factoring agreement, customers will pay the total amount directly to the factoring company. If the customer fails to pay, the factor might absorb the cost or require your business to buy back the unpaid invoice. 

Once the factoring company receives payment, it pays your business the remaining invoice amount minus its factoring fee. The factoring company may withhold its factoring fee from this amount or withhold its fees and commission upfront. The transaction is officially settled when this amount arrives in your business’s account. 

Factor Your Business's Invoices With FactorFox

Factor Your Business’s Invoices With FactorFox 

The invoice factoring process provides your business with several benefits, including improved cash flow, increased efficiency and freedom from traditional debt to meet short-term liquidity needs. Comparing your options for a factoring company enables your business to choose a trustworthy factor that provides the terms and services you need. 

At FactorFox, we offer factoring services for businesses in multiple industries that want to factor their invoices. As the original factoring software, we’ve carried our commitment into our factoring services to provide an all-in-one factoring solution. Our clients benefit from fast turnaround, competitive pricing, advanced customer support and an increasing list of additional features to meet their cash flow needs. 

Contact us today to learn more about FactorFox’s efficient, pay-as-you-go factoring services. 

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