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What’s Invoice Factoring and How Does it Work?

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Invoice factoring is a funding tactic that enables small business owners to leverage unpaid customer invoices. The method is a type of accounts receivable financing that converts outstanding invoices into immediate cash.

Invoice factoring isn’t a loan. Rather, you sell your invoices at a discount to a factoring company.

How Invoice Factoring Works

Invoice factoring is a financing option available to businesses that invoice other businesses and the government. Invoices due within 90 days are converted into immediate cash for use by your business.

After checking on the creditworthiness of your billed customers, a factoring company buys your invoices and then pays you for those invoices. The first payment consists of an advance of approximately 70 to 90 percent of the worth of the invoices. The factoring company pays a second and final installment after your clients pay. This consists of the remaining 10 to 30 percent, minus factoring fees.

Reasons to Use Invoice Factoring

Invoice factoring is a workable funding method if your company has outstanding invoices and requires fast cash. The quick funding buys you time, enabling you to take better control of your company’s expenses.

Invoice factoring is much faster than other funding methods, such as applying for a traditional bank loan. You also don’t have to put up any collateral as you would with an unsecured loan. Once you complete the transaction, the factoring company owns your invoices outright.

Drawbacks of Invoice Factoring

The main pitfall of factoring is the fact that you only collect on a portion of money owed to you. You essentially pay a fee to receive the money due you by your customers.

Invoice factoring is a potentially useful form of raising quick working capital. Considering the pros and cons will help you decide if it’s the right decision for your company.

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