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What is a factoring company?

February 14, 2022

Factoring companies offer ‘invoice factoring services’. In effect, they buy a supplier company’s unpaid invoices at a small discount to help the business free up cash.

This can be especially valuable to suppliers/exporters that need cash now but are selling goods to their buyers on ‘deferred payment’ terms. Such terms may require the supplier to wait 30-120 days for payment, causing cash flow difficulties when wages and other running costs need to be paid. This is where a factoring company can help. It can advance a proportion of the invoice value (typically 70% - 90%) as soon as the goods are shipped, with the balance (less a pre-agreed fee) sent later when the invoice is paid by the buyer. In this arrangement, the supplier gets the liquid capital it needs by paying a modest fee.

In the above arrangement, the factoring company becomes the owner of the invoice together with the responsibility for collecting payment from the buyer on the invoice due date (e.g. after 120 days).

Factoring companies often act as an alternative to banks that refuse bank credit to suppliers – perhaps because the requested loan amount is too high, the business has exceeded its credit limit or has an insufficient track record, or the supplier is deemed a poor credit risk.

If you’re working with deferred payments and need fast access to cash, working with a factoring company can be a quicker and more convenient alternative to banks – and you’re more likely to be approved.

For more information on different types of invoice factoring to discover which one makes the most sense for your business, check out our dedicated guide.

 

How do factoring companies work?

Factoring companies give businesses access to immediate capital by buying their unpaid invoices, advancing them money when goods are shipped and taking a small, pre-agreed fee when the invoice gets paid at a future date.

Suppliers often work with delayed payment terms, typically receiving payment 30 - 120 days after the goods are shipped. This restricts their cash flow and means they may be unable to pay their own suppliers or access the capital they need to grow their operations. Invoice factoring companies can bridge this cash-flow gap.

The invoice factoring process works in the following way:

  • A supplier owns an unpaid invoice with delayed payment terms.
  • A factoring company buys that invoice and advances a percentage of its face value (typically 70-90%).
  • The factoring company now owns the invoice, including responsibility for chasing late payment and may even assume the loss if the buyer cannot pay (this is called ‘non-recourse financing’ and provides non-payment protection for the supplier).
  • On the date the invoice is due for payment, the buyer pays the factoring company its full amount.
  • The factoring company then pays the supplier the balance they are owed, minus a small fee.

For example:

ABC Supplier owns $1 000 000 (USD) of unpaid invoices for goods shipped to XYZ Buyer Ltd. on 120-day terms but needs access to cash now. 

A factoring company such as Stenn buys the invoices from ABC Supplier and advances them 90% of their face value ($900 000 (USD)).

XYZ Buyer later pays the full $1 000 000 (USD) to Stenn at the agreed date (e.g. 120 days after the goods were shipped).

Stenn then pays the remaining 10% ($100 000 (USD)) to ABC Supplier, minus a small, pre-agreed fee.

 

For more information on invoice financing and how it works, check out our walkthrough video:

 

 

Which industries use factoring?

Businesses in any industry can benefit from invoice factoring but the service lends itself to sectors that frequently trade using deferred payment terms. These typically include:

  • Manufacturing
  • Construction
  • Technology
  • Food and beverages
  • Distribution
  • Oil and gas

Many factoring companies specialise in specific industries or services (for example, Stenn concentrates on consumer goods and services such as software development and consulting) while some, again like Stenn, deal only with invoices from international, rather than domestic, trading.

 

How much does factoring cost? And how are fees calculated?

Invoice factoring costs are typically charged as a percentage of the invoice amount. For example, if a factoring company charged a 1% fee for an invoice sum of $100 000 (USD) they would take $1 000 (USD) from the final invoice amount.

The amount a factoring company charges depends on the terms of the agreement, including:

  • The invoice amount – the higher the cost of the invoice, the greater the risk the factoring company assumes, which can be reflected in its fee.
  • The length of the invoice term – deferred payment terms typically range from 30 - 120 days, with longer terms often reflected in higher fees.
  • Buyer quality – factoring companies will review the buyer’s reputation and credit worthiness to assess its risk, which can also affect the fee.

For invoice factoring fee estimates with Stenn, check out our ‘cost-efficiency calculator’.

 

Is invoice factoring a loan?

No. Invoice factoring is not a loan because businesses are not borrowing any money that is not already owed to them. They simply take an advance on money that is due to be paid to them via invoices with deferred payment terms.

Invoice factoring can be used as an easier alternative to a traditional bank loan using the invoice as collateral. This is because banks are frequently unwilling to lend up to the full invoice amount - especially for newer SMEs trading internationally - or assume the risk associated with the buyer defaulting on payment.

Invoice factoring, in contrast, offers higher finance amounts and SME suppliers are more likely to be approved for funds. The application process is also likely to be faster and easier than applying for a bank loan. For example, Stenn can review applications within hours and requires only two documents to be signed before releasing funds.

 

How to choose the right factoring company

If you’re looking to partner with a factoring company to finance your invoices, it’s important to make sure they are the right fit.

Key considerations when choosing an invoice factoring company include:

  • Does it understand your industry and have experience of working with similar businesses?
  • Does it work regularly with businesses of similar size to yours?
  • Does it offer ‘recourse’ or ‘non-recourse’ financing, and which of these do you need? (To find out more about the types of factoring services, check out our dedicated guide.)
  • How many (or how few) invoices is it willing to fund and for what maximum finance amount?
  • What are its fees?
  • How much of the invoice is it willing to advance upon shipment of goods (e.g. 70% or 90%)
  • How long and complicated is the application process?
  • How long has it been in business and what is its reputation?

Using the above questions will ensure that you find an invoice factoring provider that’s right for you.



FAQs

  • Are factoring companies safe?

Invoice factoring is a safe, legal and common financial service, especially for cross-border traders. While the invoice financing industry is unregulated in the UK, it entails less risk than alternative lending options because suppliers are not borrowing money or paying interest. They are simply taking advances on funds already owed to them. 

However, as with any financial agreement, businesses are advised to do their due diligence before working with any service provider.

  • Does the company need to be local?

No. Modern invoice factoring can be done via the Internet, with documents being signed electronically and funds paid via bank transfer. 

Stenn specialises in cross-border finance, working with suppliers and buyers that operate in different countries. We are experts in international finance.

  • What is forfaiting?

Forfaiting is an example of ‘non-recourse financing' in which the finance provider (the forfaiter) assumes the risk associated with non-payment by the importer. Forfaiting is a means of financing that enables exporters to receive immediate cash by selling their invoices at a discount through an intermediary.

  • Can invoices be factored selectively?

Selective invoice factoring – or ‘spot factoring’ – is when a supplier chooses specific invoices to factor, rather than selling all of its unpaid invoices. 

This gives suppliers the flexibility to increase their cash flow with capital advances in the short term, but without incurring fees based on their whole ledger.

  • What is reverse factoring?

Many factoring companies offer ‘reverse factoring’ services – in which a buyer uses a factoring company to pay their supplier’s invoice, giving the buyer more time to pay the invoice at a later date. 

Reverse factoring benefits all parties by freeing up capital for the buyer and supplier and allowing the factoring company to charge a small fee for its services.    

 

About the Authors

Stenn is a registered member of the ITFA, IFA and WOA. It has financed invoices worth over $7 billion (USD) to date and provides:

  • An online platform for easy applications.
  • Non-recourse factoring (i.e. full protection against non-payment of invoices).
  • Rapid assessments (usually within 15 minutes).
  • Cash advances within 48 hours, with only two documents to sign.
  • Advances of between $10K (USD) to $10M (USD).
  • Fees that begin at 0.65%.
  • Advances on international deals that other companies and banks can’t, or won’t, finance.
  • Services in 74 countries.
  • Reverse factoring (buyers can use Stenn to pay immediately and settle the invoice later with us).

This article is authored by the Stenn research team and is part of our educational series. © 2021 Stenn International Ltd. All rights reserved. Any redistribution or reproduction of part or all of the contents in any form is prohibited other than the following:

  • You may copy the content to your website page but only if you acknowledge this website as the source of the material and provide a back link to this article.
  • You may not, except with our express written permission, distribute or commercially exploit the content in any other way. 

Disclaimer: The above article has been prepared on the basis of Stenn’s understanding of current invoice factoring. It is for information only and doesn’t constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.

 

Discover our other guides

To find out more about different types of trade finance, check out our other informational guides.

Alternatively, contact our team of friendly invoice factoring experts to discover if Stenn can support you with your unpaid invoices.