Factoring allows your business to receive a cash advance on unpaid or open invoices. The factoring company, or factor, reviews your invoices or receivable accounts, evaluates client creditworthiness, and determines an "advance amount," or the percentage of the invoice amount that you will receive as cash payment. If an agreement is reached, the invoice is "assigned" to the factor, and you receive payment. THe factor then has the right to collect on the invoice directly from your customer.
The factoring process is simple and is usually very fast. First, you will need to collect and make copies of the unpaid invoices you wish to sell. The factor evaluates the invoices and verifies client's credit. If an invoice is approved, the factor will determine the advance amount and the "factor rate," or the fee it will charge for advancing money against the invoice. This fee is usually expressed as a percentage of invoice value, and can be anywhere from 2 to 20% of the invoice total. THe more reliable your customer, the lower the rate.

Within a few days of application, the factor will transfer you the advance, usually 70 to 90% of the invoice total. Once the customer has paid the bill in full, you will receive the balance of the invoice less the factoring fee. Factoring is an alternative form of short-term financing that can be expensive if the terms aren't right- make sure you get reasonable percentages for advance amounts and factor rates.
Businesses have a few different options when it comes to factoring. Recourse factoring is the less expensive, but riskier, of the two options. With recourse factoring, your business is responsible for the invoice if the customer doesn't pay, meaning that you'd need to return the advance amount (usually plus a fee) and pay the factoring charges. An invoice can also be guaranteed or secured with business property. Non-recourse factoring is more expensive, but transfers the risk to the factor if your client cannot make payment. Set up costs for both types of factoring services can range from $500 to $2,000, to cover the factor's costs for customer credit checks and invoice validation.

The benefits of factoring are speed and convenience. Since factoring is not a loan, it is a sales transaction, there are no credit checks on your business and no long application process. Businesses that are unable to qualify for traditional methods of financing often choose factoring for these reasons. Factoring services usually remit advance amounts within just a few days of application. Other businesses see factoring as a cost-effective way to outsource collection functions.

There are some potential downsides to using business factoring services. Before signing a contract, consider the rates you will pay if you have slow paying clients, or if your client does not meet the factor's standards for ability to make payment. If you use recourse factoring, you may be liable for the entire amount plus costs if your client fails to make the payment.

Choosing the correct factoring service will also have a big impact on your experience. Pay attention to the factor's professionalism with you and your clients, the time the factoring company has been in business, and any feedback from references. Gather as much information as you can from each candidate. Make sure to get quotes from each factor, and see if these terms are negotiable. You can also use a broker to help you seek out the best prices for the services you need.