Technically factoring is not a loan; it is the purchase of future receivables. A third party, known as a factor, purchases a company’s invoice(s) or purchase order(s) at a discount giving a business owner access to a percentage of that invoice or purchase order now, instead of when the invoice or P.O. is paid. The balance, minus the agreed upon discount, is paid to the business owner once collected by the factor.
For example, if you had an invoice for $10,000, using a factor (or factoring that invoice) would allow you to access a percentage now, and the balance, minus the factor’s fee when the invoice was paid. Every factor is a little different, but let’s say the factor paid you $8,000 now and the factor’s fee was 6%, the transaction would look like this:
$8,000 today + $2,000 – $600 (factor fee) when the invoice was paid
Basically, you sold the $10,000 invoice for $600 to access the capital now, instead of later.
You can read more about factoring in our Business Owners’ Guide to Factoring.