Invoice factoring

How it works

Factoring involves selling receivables to a factor. Depending on the arrangement, the factor pays most or all of the eligible invoice value upfront, less fees, and may hold back a reserve for later settlement. Invoice validity, customer payment risk and the agreement determine the actual cash flow.

Where it can fit

Businesses selling on commercial payment terms can use factoring to reduce the wait for cash. It is especially relevant when sales are growing faster than available working capital. It does not fix disputed invoices or customers who are unlikely to pay.

Look closely at the trade-offs

Find out who communicates with customers and collects payments. Recourse terms can leave the business responsible for unpaid invoices. Review aging fees, reserve release, minimum volumes, concentration limits, and termination provisions before comparing an advance percentage.

Trace the advance, reserve and settlement

Use a fictional $50,000 eligible invoice with an 85% advance and a $1,500 total fee, charged at settlement. The initial cash is $42,500. The remaining $7,500 is held back. If the customer pays the full invoice and no other deductions apply, the final release is $6,000. Across both payments, the business receives $48,500.

The $7,500 holdback is not an extra $7,500 cost in this example. It is the part of the invoice that was not advanced, and $6,000 of it eventually arrives. Different providers may advance a different proportion, deduct fees earlier or use a different settlement structure. Request the actual sequence in writing.

Source: FundThrough: factoring fees and related terms

Late payment changes more than the collection date

Stress-test the same invoice with payment arriving later than expected. If the fictional contract added a further $500 charge deducted from the holdback, the final release would fall to $5,500 and total receipts to $48,000. The original $42,500 arrives at the same time, but the final cash is both later and smaller.

Do not mistake this example for a provider’s fee schedule. FundThrough’s own help guidance describes circumstances in which an unpaid invoice can result in a repayment plan and additional fees. Ask your provider what happens after each overdue milestone and whether the business must repurchase or repay the invoice.

Source: FundThrough: when a customer pays late

Separate customer credit risk from a disputed sale

Receivables financing depends on what is actually collectible. A delivered order with an accepted invoice is different from an invoice disputed because goods were returned or work was incomplete. The OCC’s handbook discusses controls and risks around receivables financing and recourse arrangements.

For each large customer, assemble the invoice, purchase order, proof of delivery or acceptance, payment history and any credits or disputes. Ask which risks remain yours even if a product is described as non-recourse. The label alone is not a complete description of the contract.

Source: OCC: accounts receivable and inventory financing

Plan the customer conversation and final reconciliation

Ask who sends the notice of assignment, who answers a customer’s payment questions and where payments should be sent. If a customer accidentally pays your business, find out the required handling before it happens. A clear process protects the customer relationship as well as the cash forecast.

Keep a reconciliation with five columns: invoice value, first advance, customer receipts, fees or deductions, and final release. If $48,500 was expected in the first example but only $47,900 arrived, the $600 difference should have a documented explanation. Avoid calculating the cost from a headline percentage while leaving unreconciled deductions in another part of the file.

The U.S. bank-supervision handbook and individual provider examples are references for mechanics, not universal contract rules. Available products, legal treatment and obligations vary in Canada and the United States.

Ask your broker

• What is paid now, held back and released later?
• Who bears a non-payment loss and which exceptions apply?
• What changes if the customer disputes the invoice or pays late?

Your next-step checklist

• Aged receivables report
• Customer concentration
• Proof of delivery and invoices
• Recourse and collection terms