Summary: Most factoring companies advertise that they provide an advance of 80% to 90% of the invoice, depending on the client’s industry. For example, a manufacturing company with solid clients will likely get an advance of 80% to 85%. On the other hand, a staffing agency with similar clients will get a 90% advance. This variation can sometimes confuse clients – why is the client’s industry so important?
This article explains how factoring companies determine the initial advance. It covers:
- Factoring basics
- Understanding and managing risk
- Why do staffing companies get a high advance?
- Two examples
- How to negotiate a higher advance
1. Factoring basics
Invoice factoring helps companies by financing their net-30 to net-60 invoices. It advances funds to your company, so you don’t need to wait for your customer’s payment. Getting the advance is useful for companies that don’t have large cash reserves and have problems managing net-30 accounts.
Factoring companies finance invoices in two instalment payments. The first instalment is called the advance. Your company gets the advance soon after the invoice is submitted. It can be as high as 95%, depending on your industry. The remaining funds, less the factoring company’s fee, are deposited into your account once your customer pays. For more information, read “What is Factoring?” and “How Does Invoice Factoring Work?”
2. Understanding and managing risk
The advance percentage from the first instalment is determined by your industry, your ability to get paid in full, the end customer’s credit profile, and the transaction’s general risk. The amount advanced is the primary risk exposure of the factor. Consequently, lower-risk transactions usually command the highest advances.
A staffing agency usually gets some of the highest possible advances because they have lower risk profiles than other industries. To understand the finance company’s viewpoint, let’s examine each risk parameter in detail.
a) Industry
Factoring companies can offer services in most industries. However, factoring is popular with staffing companies. Staffing agencies often rely on factoring to make payroll, especially if they are growing. Factors know this industry well and understand how to limit their risk. This industry knowledge allows them to offer a higher advance.
b) Ability to get paid in full
The main risk that factoring companies face is that the end customer won’t pay an invoice in full. The most common reason for an underpayment is a dispute.
Credit memos, also known as chargebacks, are common in some industries. For example, it is not unusual for companies that manufacture or distribute large quantities of products to have some defective units in a shipment. These units are returned and deducted from the invoice.
Most factoring companies can determine if an invoice will be subject to a credit memo when they verify it. However, this process is not perfect and does not detect all potential issues. The factor adjusts the advance to reflect potential underpayments.
Staffing companies have simple billing practices and use signed time cards (or a similar process). The cards are signed by the customer, who confirms the hours, work, and other details. These invoices are simple to verify and are usually paid in full. Consequently, the risk of underpayment is low in the staffing industry. This lower risk translates into higher advances for staffing agencies.
c) Customer’s commercial credit
Your customer’s commercial credit plays a role in determining the size of your company’s advance. Most factoring companies never advance more than a certain percentage for certain industries. However, they may reduce the advance to limit their exposure if your end customers don’t have great commercial credit.
d) Other considerations
Other considerations can affect the advance percentage. These issues are usually specific to a company and a transaction. For example, companies undergoing significant management changes may have a lower advance until the factoring company better understands the new team’s risk profile.
3. Why do staffing agencies get a high advance?
Staffing companies get high factoring advances because finance companies consider them to have a lower default and underpayment risk. Most factoring companies know the industry well and have created risk-reduction processes. Furthermore, invoices can be verified easily and accurately, which reduces the chances of underpayment.
Keep in mind that staffing companies are not guaranteed a high advance. The actual advance depends on all the transaction’s details. A staffing company with a high risk may get a lower advance.
4. Two examples
The following two examples show how factoring companies set the advance. One transaction is for a staffing company, while the other is for a manufacturing company. These examples allow you to compare how advances are determined in both transactions.
a) Staffing company
A staffing company provides staffing services to Fortune 500 clients. At the end of the week, customer supervisors sign the time sheets for each staffing employee. The sheet indicates the number of hours worked and their satisfaction with the work.
A signed time card from the customer leaves very little room for an invoice dispute. The signed time card indicates their acceptance of the worked hours. Most factoring companies consider the combination of an invoice and a time sheet as strong evidence that the work was done and that the invoice will be paid in full. Therefore, the factors are willing to offer a higher advance.
b) Manufacturing company
A manufacturing company provides machine-made widgets to Fortune 500 clients, who buy them in bulk. These customers have a similar credit profile to the customers in the previous example.
The goods are manufactured and then shipped by freight carrier to the destination. Generally, the receiving company performs a quick inspection and either accepts or rejects the shipment. However, an accepted shipment does not mark the end of the transaction. If some products are later found defective, the cost of these defective items will be deducted from the invoice.
It’s difficult to determine if the invoice will be paid in full since small manufacturing errors are common. And, as mentioned before, defective items are deducted from the invoice. This uncertainty (even if small) over the invoice payment amount increases the risk of underpayment. Consequently, this reduces the advance to the range of 80% to 85%.
5. How to negotiate a higher advance
The best way to negotiate a higher advance with a factoring company is to show them that your transaction has a lower-than-expected risk. You can do this by:
- Having good invoicing practices
- Following up with customers to ensure their satisfaction
- Having a good collections track record
- Keeping up to date with your accounting
- Ensuring all customer interactions are professional
Get more information
We are a leading factoring company and can provide staffing agencies with high advances at low rates. For more information, get an online quote or call us toll-free at (877) 300 3258.