Can Invoice Factoring Help with Collections Problems (Problem Invoices)?

Some business owners have the misconception that factoring companies can finance “troubled invoices.” Factoring improves your cash flow by financing slow-paying invoices. However, it won’t help with invoices that have collections problems. A factoring company will not finance those invoices.

This article explains how factoring works, how factoring companies determine credit quality, and why they can’t finance invoices with collections problems. We cover:

  1. Invoice factoring basics
  2. What type of invoices do factors buy?
  3. How do factoring companies handle unpaid invoices?
  4. How to improve collections and avoid problems

1. Invoice factoring basics

Invoice factoring enables companies to finance invoices that are due in 30 to 60 days. It is commonly used by small and mid-sized companies that need to improve cash flow. Most factoring companies don’t lend money. Instead, they buy your invoices from creditworthy commercial clients at a discount. This structure has simpler qualification requirements and provides immediate access to funds. Learn more by reading “How Does Invoice Factoring Work?

There are two ways to structure factoring transactions: with recourse and without recourse. Both options offer similar benefits but differ in how they handle some unpaid invoices.

a) Recourse factoring

Most factoring companies specialize in recourse factoring. In a recourse transaction, your company sells its accounts receivable to the factor with the assurance that your customers will pay in full. Your company remains responsible for payment if your customer does not pay in 90 days or less.

b) Non-recourse factoring

Non-recourse transactions are similar to recourse transactions, with one important exception. You are not responsible for payment if your customer defaults due to insolvency. This distinction is often a source of confusion among some prospective clients who think factors absorb any losses. Note that your company is always responsible if your customer does not pay your invoice for other reasons, including disputes.

2. What type of invoices do factors buy?

Factoring companies only buy high-quality invoices. In most cases, they expect the customer will pay the invoice in 90 days or less. Finance companies use a commercial credit report to verify the credit quality of the company paying the invoice. These reports are available from bureaus such as Dun and Bradstreet and Ansonia.

Credit reports provide statistics about your customer’s payment trends with other vendors. They can also provide information about legal filings and other events. The report combines this information to estimate the company’s credit and chances of default. Factoring companies also verify your invoices with your customers. Verifications are done through your customer’s vendor portal or via email. This process enables the factor to determine if the invoice is open and accurate.

The combination of credit reviews and invoice verifications enables the factor to determine the quality of the invoice. Invoices that meet the factoring company’s quality guidelines qualify for financing.

a) Types of invoices that factoring companies won’t buy

A factoring company won’t buy an invoice if there is a high likelihood that it won’t be paid. Any invoice that is not payable by a creditworthy company or does not pass the verification process cannot be funded. For this reason, a factoring company cannot finance invoices that are considered “collections problems.”

Examples of invoices that cannot be factored include invoices that:

  • Are late and beyond terms
  • Are subject to disputes
  • Are due from troubled companies
  • Haven’t been fulfilled
  • Are payable in more than 90 days

3. How do factoring companies handle unpaid invoices?

Factoring companies are very good at determining the credit quality of an invoice. However, sometimes they buy an invoice that does not pay. These invoices are handled based on the type of factoring you have and the reason for non-payment.

a) Recourse factoring

Factors can return any past-due invoice to the client under a recourse agreement. Each factoring company has specific processes and rules for returning invoices. Finance companies are aware that returning an invoice can affect their client’s cash flow. Most will make accommodations to help minimize the impact on the client’s finances.

b) Non-recourse factoring

There is no standard way of offering non-recourse factoring, and each finance company offers a custom version. Some programs offer broad protections, while others provide narrow protections. The exact details are in your contract.

In most cases, non-recourse factoring companies absorb a loss if your customer did not pay due to a declared bankruptcy. Invoices that aren’t paid for any other reason, including disputes, can be returned to the client.

4. How to improve collections and avoid problems

The best way to handle collections issues is to prevent them in the first place. It’s a matter of having the right process and using it consistently. You can minimize your chances of ending up with unpaid client invoices if you follow these five steps:

a) Check your customer’s business credit

Check the business credit of your clients before signing your contract. Commercial credit reports are affordable and are cheaper than handling collections problems. Consider getting two or more reports from different bureaus if your customer places a major order. This step provides a more comprehensive credit picture.

b) Use a well-written contract

Small businesses often perform work or sell products without using a contract. This practice usually backfires when something goes wrong or when a customer refuses to pay their invoice. Work with an attorney to develop a contract suited to your company. Make sure the contract includes a clear, well-written payment policy.

c) Use a delivery acceptance document

A well-crafted delivery acceptance letter can decrease disputes and increase client satisfaction. It should be crafted with the help of an attorney and include a description of the work/product you delivered. A representative of your customer needs to sign the letter to indicate their satisfaction with the delivery. The purpose of the letter is two-fold. It identifies potential delivery issues and enables you to address them immediately. The letter also helps you handle payment disputes that happen later on.

d) Submit invoices correctly

Many large companies have detailed invoice payment procedures that vendors must follow. These procedures often require invoices and backup documentation to be submitted via a portal, often with copies sent to specific departments. Follow your client’s invoicing process carefully. Invoices that are not submitted using the correct process are often delayed.

e) Follow up regularly

Every company should have an invoicing and collections process that they follow consistently. Suggestions include:

  • Verify your customer got the invoices
  • Follow up a few days after the due date
  • Negotiate alternate payment arrangements if needed
  • Follow up with slow payers regularly (but not constantly)
  • Be professional and polite
  • Contact an attorney if all else fails

Get more information

Are you looking for a factoring quote? We offer high advances at low rates. For more information, call us toll-free at (877) 300 3258.