Definition of financial term - Invoice Factoring

What is Invoice factoring

It is a type of business financing which involves selling a company's accounts receivables, at a discount, to a financing company.

The financing company can take on the credit risk of a company's debtors and will get paid back when debtors settle the full amount of their invoice.

Who is involved?

There are 3 parties in invoice factoring:

  • - the company wishing to use factoring services
  • - the financing company offering factoring services, often called a 'factor
  • - the customer who owes money to the business for products or services.

Factoring example

  1. a customer owes a company £10,000 for products or services and fails to pay the company within the company's 60 day payment period
  2. the company owed this money decides to increase its cashflow using a factor
  3. the factor checks what is owed by the customer
  4. the factor transfers 80% of the invoice total to the company's bank account (£8,000) within 24 hours
  5. at the end of the 60 day payment period, the company receives the remaining 20% of the invoice amount minus a factoring fee of n% of the original invoice amount
  6. the factor collects £10,000 - (£10,000*n)/100 at the end of the 60 days.

Benefit from invoice factoring

The company gains from a cashflow release of £8,000 from a factor, well before the 60 day payment period ends.

Factoring benefits in more detail

  • frees up cashflow, finding funding for companies' outstanding invoices quickly, often within 24 hours of invoice release
  • speeds up cashflow, allowing companies to make key payment deadlines such as payroll and, fulfil new orders
  • reduces time and resources spent collecting money
  • offers better terms to large customers to help increase sales. For example, extending credit to large customers
    • without asking for cash on delivery helps a company to retain a competitive edge over other firms
  • manages debt reduction, ensuring that no new debt is created
  • enables payment to suppliers faster, taking advantage of early pay discounts
  • funding rises with company growth, the more invoices a company makes, the more funding can be accessed
  • creates instant credit guarantees for new customers
  • can improve company credit rating.