Invoice Financing - Invoice Factoring

What is invoice financing?

Invoice financing is the business of lending a customer money in exchange for unpaid client invoices as collateral. The customer will pay back the lent money by a certain deadline, plus fees associated with the service. No relationship is established between the invoice financing company and the customers clients.

What is invoice factoring?

Invoice factoring is the business of purchasing unpaid invoices from a customer and directly collecting the payment from the customers client. The client now has a new relationship to maintain but the customer can offload payments and collections to the factoring company in exchange for a fee.

There are 2 types of factoring, each with their own associated costs:

Recourse factoring: In the event the client cannot pay the invoice, the factoring company can hold the customer liable for any remaining unpaid amount. The customer still holds the credit risk . Pricing for this type of factoring is 1-2% depending on the country and contractual relationship.

Non-recourse factoring: In this case, the factoring company owns the debt and also holds the credit risk. Customers essentially sell the credit risk and payment collections to the factoring company, but for larger fees than recourse factoring. Pricing for this type of factoring is much higher, from 2-5% of the invoice amount, and even higher depending on the risk of the invoice.

How does each type operate?

Invoice financing companies will examine a customers book of business before offering terms to finance the operation. Quarterly exports and reporting from the customer is required to keep the incoming cashflow stable from the financing company.

Invoice factoring will want to purchase as much of the customers invoices as possible, but requires invoice level data to make decisions and has the right to refuse to buy any invoice. Factoring companies may start a relationship with just a few invoices from a customer, and prefer to have a direct connection to their accounting system in order to best understand the risk of the relationship between the customer and client.

Due to the tighter data connection to the customer, factoring operations prefer to rely on automation in decision making to scale their business cost-effectively in order to provide the lowest price vs. their competitors.

How does non-recourse factoring mitigate credit risk?

Factoring companies who own the credit risk have a few options:

• Assume the credit risk and purchase a standard credit insurance policy to cover specific clients of your customer. Policy premium is paid up front based on a projected volume for the year. The insurance cost can be included in the fees taken from the customer. Downsides include not being able to get real-time decisions on new clients to add to your policy and scaling your business may require a renegotiation of your insurance policy mid-year to increase your coverage.
• Use a credit insurance API to get real-time insurance quotes for customer invocies to automate your purchase decisions. In this scenario, a factoring company can build a direct data connection or offer a customer portal where insurability per invoice is checked in seconds and your insurance cost can be embedded into the factoring fee. This is more of a pay-as-you-go approach to credit insurance.
• Assume the credit risk and do nothing.