Invoice factoring companies receive an immense number of applications. In fact, the market for invoice factoring in the United States is $4 billion, with more growth predicted in the future. If you're one of the businesses looking to apply, going through the application process in an organized and tactical manner is key.
While the application may look straightforward, mistakes and oversights can lead to rejection. You don’t want to rush your application and ruin your chances of approval because, without invoice factoring, your working capital might suffer a huge dip, putting your business at risk.
Avoiding that outcome is easy. By understanding the application process for invoice factoring, you can significantly impact your success when you apply. In this article, we’ll look at how to prepare a successful invoice factoring application.
Quick Refresher: The Essentials of Invoice Factoring
Invoice factoring or invoice financing is a form of financing for a business's accounts receivable.
As a business, once you sell goods or services, customers might take a few weeks to deliver their payments to your bank account. Under accounting principles, the payments you’re waiting for are recognized as revenue under accounts receivable.
With invoice factoring, you sell your accounts receivable or unpaid invoices to a factoring company — or factor — at a discount in exchange for a cash advance.
The factoring company might agree to recourse factoring, which means that if the customers don't pay back their invoices, you, the business owner, are responsible for covering them. Or they might agree to non-recourse factoring, in which the factoring company bears the risk of non-payment from your customers.
Business owners use invoice factoring if they run out of options for other business financing and need cash to pay their monthly minimum fees — rent, utility, wages, and other non-flexible expenses. Small businesses that run on a seasonal cycle also use invoice factoring to pay their bills during their slow season.
Ready to boost your cash flow with invoice factoring? Apply now to get the process rolling.
How Does Invoice Factoring Work?
The way invoice factoring works is relatively straightforward. A factoring company purchases your outstanding invoices and provides an advance. The advance goes to your bank account, and you can use it to substitute your accounts receivable.
But, factoring companies are businesses of their own and need to make a profit. As such, they won't pay 100% of the value of any unpaid invoice but rather a percentage.
Some factoring companies will give you 90% of your invoice payments. That means you will get 90% of the value of your accounts receivable upfront.
Once you receive your advance, you no longer need to chase after your customers to pay. Now, customers pay the factoring company — they are responsible for collecting the accounts receivable, not you.
When customers pay their invoices to the factoring company, the factor will give you the remaining funds they owe you.
So if they initially advance you 90% of the funds, you will get the remaining 10% after customers pay, minus fees. The factoring company will take a percentage of the remaining 10% for their fees, such as a factoring fee and invoice processing.
In the end, you’ll likely end up paying between 1% and 5% of the value of your invoices — that’s the factoring cost
Let's look at an example:
- A small business owner has an outstanding invoice of $100,000.
- They apply for invoice factoring, and the company agrees to give them 80% of their accounts receivable. The business owner gets $80,000 upfront, and the factoring company holds the remaining $20,000.
- When the customer pays their invoice, the factoring company calculates how much money they owe you.
- This company takes a 1% invoice factoring rate from the total value of the invoice for each week that the payment is delayed.
- If the customer takes three weeks to pay the invoice, that's a 3% factoring rate on the $100,000 invoice value.
- So the factoring company will hold $3,000 as a result of their invoice factoring rates.
In addition to the factoring fees, you might also have to pay an additional 3% in processing fees, so the invoice factoring company will retain $6,000 in total, and you will get an additional $14,000 on top of the initial $80,000.
So, all in all, you will have $94,000 out of the $100,000 you were owed.
How to Apply for Invoice Factoring
The invoice factoring application process can be easy and quick once you know the steps. Depending on your business's financial situation, you might get approval in a week and receive most of the cash for your outstanding invoices.
Step #1: Choose Your Factoring Company
The factoring company you choose makes a crucial difference in the success of your invoice factoring application. They decide the criteria business owners need to meet to qualify for this method of financing. Additionally, they set factoring rates and fees.
So depending on the invoice factoring company you choose, you may end up with more or less money.
The industry is full of companies offering invoice factoring services. You can choose between general factoring companies, those that finance only business-to-business (B2B) or business-to-customer (B2C) businesses, industry-specific companies, and more.
Once you've done your research and narrowed down a list of factoring companies that are suitable for your situation, compare their policies, years of experience, as well as costs and conditions. Once you have this information and choose the company you want to apply with, you can start the application process.
Step #2: Fill Out the Factoring Application
Whichever company you choose for invoice factoring will require a completed application form to initiate the process. This application is usually easy to fill out and requires basic information, such as:
- Company name
- Type of business
- Business owner's personal information
- Activities your business engages in
- Contact information
- Information on your customers
- Information on your outstanding invoice value
The type of business you have and the information on your customers play a huge role in determining your eligibility and chances for approval. Most factoring companies want to work with stable businesses who have well-performing customers and evidence of timely-paid invoices.
Once you submit the filled-out application form and submit to the factoring company, you can move on to the next step.
Step #3: Submit an Updated and Accurate Aging Report
One of the most important documents you should submit after the invoice factoring application is the aging report. An aging report shows a list of your customers and the time it has taken them to pay their invoices in the past.
The report could reflect invoice payment times for one or multiple years, depending on how long you have been in business and the type of customers you have. Make sure to ask the invoice factoring company about the time period the aging report should cover.
The factoring company will analyze the report to determine how responsible your customers are. Customers that pay their invoices within 30 days are the most attractive.
Slow-paying customers who pay invoices between 45 to 60 days or 60 to 90 days aren’t as attractive. However, the factoring company might still approve your application based on other criteria or request supporting documents.
Step #4: Submit Supporting Documents
On top of your aging report, you should also submit additional supporting documents demonstrating the company's performance, your credit score, any cash flow problems you might have, other outstanding business loans, and other relevant financial information. These supporting documents can be:
- An accounts payable report, which details what you owe to other entities
- Personal tax returns for the last three years
- Business tax returns for the last three years
- Financial statements, including balance sheet, cash flow report, and income statement for the last three to five years
- Proof of business ownership
- Personal credit score report
- Business credit score report
Step 4: Assist in the Underwriting Process
The underwriting process is the verification process for your invoice factoring application. The company will evaluate the strength and truthfulness of your application because they want to know if there are any legal blocks that could pose a risk when trying to recover what they’re owed from your customers.
The due diligence process can take between five to 10 days, depending on the number of documents you submit and how long it takes the factoring company to make a thorough evaluation.
They will perform a search of your and your company's public records. They’ll also look into your corporate status, judgments, liens, pending litigation, back taxes, criminal records, and anything else that might indicate you can’t sell your accounts receivable.
Invoice factoring is a risk for these companies. Your customers might refuse to pay and default on their payments. Additionally, there might be legal roadblocks that stop a factoring company from collecting payments from your customers.
That's why the underwriting process makes a huge difference in determining the soundness of your application and paves the way for you to get the needed cash flow.
Step #5: Get Approval and Fund Disbursement
If the factoring company has determined it will be able to collect payments from your customers, they’ll approve your invoice factoring application.
You’ll need to sign a factoring agreement before you receive your advance. Read through it and make sure you understand the conditions, the discount rate or financing rate, and any maintenance fees.
The factoring company agrees to advance you a percentage of your outstanding invoices, for example, 90%, and you receive a lump sum in your bank account.
After a few weeks, when your customers pay their invoices to the factoring company, they’ll take out their fees, and you will get the rest of the money, which you can use to close your cash flow gaps.
3 Common Reasons for a Rejected Invoice Factoring Application
Even if you submit all your documents and information in order, your invoice factoring application could still be rejected. Here are a few reasons why you could get a rejection notice and how to resolve them.
Reason #1: Small Invoices
Many factoring companies will have a minimum invoice amount that they factor. As such, any applications that do not meet that minimum amount may be rejected.
As a small business owner, you can mitigate this by building your customer base and generating larger invoices. Then, you can apply again later. You can also look for alternative business finance opportunities, such as credit lines, low-interest loans from the Small Business Administration (SBA), and merchant cash advances.
Reason #2: Low Volume of Invoices
In addition to the amount of each invoice, some factoring companies require a high volume of invoices to approve your application.
If you don't meet these criteria and have your application rejected, you can try different strategies to increase your invoice volume, such as running a discount or sale on your products to attract buyers.
Reason #3: Bad Aging Report
One of the main reasons applicants don't get approval for invoice factoring is a bad aging report. If your customers don't usually pay their invoices for several months and are considered high-risk, you’ll have an unfavorable aging report.
Invoice factoring companies try to stay clear of businesses with customers that don't pay their invoices within at least 90 days. There’s too much risk involved.
If you are in a situation like this, there is not much you can do. You are already facing cash flow problems because your customers haven't paid you, and if you agree to recourse factoring, you may have to pay the invoices yourself.
Your best course of action is to look for other financing solutions that work well with your type of business and current financial situation. Invoice factoring is a useful type of business financing, but it’s not your only option.
Invoice factoring is a reliable way of getting a cash flow boost, especially for small businesses struggling through a slow period. You sell your outstanding invoices and get a large percentage of them as a lump sum, allowing you to use the cash to fund everyday expenses, purchase capital or inventory, and grow your business.
While the application process is relatively easy, understanding it in depth is necessary to succeed.
And understanding your options for business financing is imperative to making the right choice. You can use a small business funding marketplace, such as AdvancePoint Capital, to get the best recommendations for financing, compare them, and apply in minutes.
Ready to apply? Get a quote now!