Invoice Factoring in Canada: Everything You Need to Know
In the world of B2B (business-to-business) sales in Canada, it is a common and often necessary practice for sellers to extend deferred payment terms to their customers. These payment terms, frequently referred to as net terms or trade credit, allow buyers to purchase goods or services upfront while deferring payment to a later date. For example, terms such as "Net 30" indicate that the full invoice amount is due within 30 days of receiving the goods or services. Other common time frames include Net 45 or Net 60, depending on the agreement between the buyer and seller.
While this arrangement provides a significant advantage to buyers by improving their cash flow and giving them time to generate revenue before paying for their purchases, it can create challenges for sellers. Deferred payments mean that businesses must wait weeks or even months to receive the funds owed to them. During this waiting period, cash flow can become strained, potentially making it difficult to cover operating costs, pay employees, restock inventory, or invest in growth opportunities. As a result, sellers may face financial stress and reduced flexibility in managing their daily operations.
To address this issue and maintain steady cash flow, many businesses turn to a financial solution called invoice factoring. Invoice factoring is a form of debtor finance in which a business sells its outstanding invoices, also known as accounts receivable, to a third-party company called a factoring company or factor. In exchange, the business receives immediate cash—typically a large percentage of the invoice value—while the factoring company assumes responsibility for collecting payment from the customer. The factoring company charges a small fee for this service, and the remaining balance is paid to the seller once the invoice is settled.
This practice can be an effective solution for businesses looking to bridge cash flow gaps without taking on debt or waiting for extended payment terms to expire. By converting unpaid invoices into readily available funds, invoice factoring enables businesses to meet short-term financial obligations, invest in growth, and manage day-to-day operations more efficiently. This guide will explain how the invoice factoring process works, the different types of factoring available, and the pros and cons of using this financial tool.
How Invoice Factoring Works for Canadian Businesses
- Issue Invoices to Clients
The process starts when goods or services are delivered to clients, and an invoice is issued for payment. These invoices typically come with payment terms, such as net-30 or net-60 days, meaning clients have 30 to 60 days to pay. While waiting for payment, cash flow may be tied up, limiting the ability to cover expenses or pursue growth opportunities.
- Sell Invoices to a Factoring Company
Instead of waiting for clients to pay, outstanding invoices can be sold to a factoring company, also known as a factor. The factoring company will purchase these invoices at a discounted rate, providing immediate cash. This allows businesses to unlock the funds that are stuck in unpaid invoices and improve cash flow.
- Receive an Immediate Advance
Once the factoring company verifies the invoices, a percentage of the invoice value—typically 70% to 90%—is advanced. This advance is transferred to a business bank account quickly, often within 24 to 48 hours. The percentage held back by the factoring company is called the "reserve" and will be paid later, minus fees.
- The Factoring Company Collects Payment
The factoring company takes over the responsibility of collecting payment from clients. This means businesses no longer need to chase down unpaid invoices or worry about late payments. Clients will pay the factoring company directly, as agreed in the factoring arrangement.
- Receive the Remaining Balance
Once the client pays the full invoice amount, the factoring company releases the reserve funds. At this point, the factoring fee, which is the cost of the service, is subtracted. The factoring fee is usually a small percentage of the total invoice amount and varies depending on factors like invoice value and payment terms.
- Improve Cash Flow and Business Operations
With cash in hand, businesses can use the funds to cover expenses, invest in new opportunities, or manage day-to-day operations without the stress of waiting for payments. Invoice factoring allows businesses to maintain steady cash flow, reduce financial strain, and focus on growth instead of accounts receivable.
Types of Invoice Factoring in Canada
Recourse Invoice Factoring
Recourse factoring is the most common type of invoice factoring. In this arrangement, the business remains responsible if the client fails to pay the invoice. If a client does not settle the payment within the agreed-upon terms, the factoring company can require the business to buy back the unpaid invoice. While this type of factoring carries more risk for the business, it is typically less expensive since the factoring company assumes less risk.
Non-Recourse Invoice Factoring
Non-recourse factoring shifts the risk of non-payment to the factoring company. If a client fails to pay the invoice due to insolvency or other agreed-upon reasons, the factoring company absorbs the loss. This provides businesses with added security but often comes at a higher cost, as the factoring company takes on more risk. Non-recourse factoring is ideal for businesses that want to protect themselves against the possibility of client defaults.
Pros and Cons of Invoice Factoring
Advantages of Invoice Factoring for the Seller
One of the most significant advantages of invoice factoring is immediate access to cash. Businesses no longer have to wait for clients to pay invoices, which can sometimes take months. This access to funds can help cover essential expenses, such as payroll, rent, and inventory, or allow for strategic investments like marketing campaigns or new equipment. With steady cash flow, businesses can better manage their day-to-day operations and take advantage of growth opportunities as they arise.
Another benefit is that the factoring company takes over collections, relieving businesses of the administrative burden of chasing down unpaid invoices. This can save significant time and resources, allowing businesses to focus on other important tasks, such as serving clients or expanding operations.
Invoice factoring is also a flexible financing option that grows with the business. The more invoices a company generates, the more funding it can access. Unlike traditional loans, approval is often based on the creditworthiness of clients rather than the business itself. This makes invoice factoring an excellent option for businesses with limited credit histories or those that may not qualify for traditional financing options.
Cons of Invoice Factoring for the Seller
Despite its benefits, invoice factoring does come with some drawbacks. The most notable disadvantage is the cost. Factoring fees, which are typically a percentage of the invoice value, can reduce overall profit margins. Businesses must carefully weigh the costs against the benefits to ensure the arrangement is financially viable.
Another potential downside is that clients may become aware of the factoring arrangement, as payments are made directly to the factoring company. This transparency may cause concern for some clients, who might interpret the arrangement as a sign of financial instability. Businesses should communicate clearly with clients to maintain trust and avoid misunderstandings.
Recourse factoring also carries a level of risk for the business. If a client fails to pay an invoice, the factoring company may require the business to buy back the unpaid invoice. This can create additional financial strain, especially if multiple clients default on payments. For businesses concerned about this risk, non-recourse factoring may be a better option, though it often comes at a higher cost.
Lastly, reliance on invoice factoring could become a long-term financial habit. While factoring is a valuable short-term solution for cash flow issues, it may not address underlying financial challenges. Businesses should evaluate their overall financial strategies and work toward building a sustainable cash flow model.
Buy Now, Pay Later for B2B: An Alternative to Net Terms and Invoice Factoring
Buy Now, Pay Later (BNPL) has surged in popularity in the consumer market, thanks to companies like Afterpay, Klarna, and Affirm, making it a key feature of online shopping worldwide. This model allows consumers to buy goods or services immediately and defer payment, often interest-free for a set period. BNPL is now entering the Canadian B2B space, providing an appealing alternative to traditional financing methods.
In the B2B space, BNPL provides buyers with benefits similar to net terms, enabling them to defer payments and preserve cash flow. For sellers, BNPL functions much like invoice factoring, allowing them to receive immediate payment while shifting payment risk to a third party. Moreover, B2B sellers have the option to either cover the BNPL provider’s fees or pass them on to buyers, a benefit that isn’t available with invoice factoring.
Introducing: Tabit Buy Now, Pay Later for B2B
Tabit, powered by Merchant Growth, is Canada’s first B2B Buy Now, Pay Later solution. Since 2021, Tabit has aimed to bring the convenience of the consumer buying experience to B2B transactions. Backed by Merchant Growth's decade-long experience in providing financing to thousands of Canadian small businesses, Tabit now partners with over 200 businesses across the country.
Tabit is a versatile omni-channel solution with two key offerings: Tabit for eCommerce and Tabit for Invoices. The eCommerce option integrates smoothly into the checkout process for online businesses, while Tabit for Invoices is tailored for businesses that don’t have an online checkout system.
Tabit for eCommerce
The eCommerce solution, tailored for online businesses, smoothly integrates Tabit into the checkout process. Customers can choose Tabit at checkout, where they’re guided through a quick application that takes just a few minutes. Instant pre-qualification provides them with loan term options, including interest rates and payment schedules.
Tabit for Invoices
Tabit for Invoices is built for businesses without an online checkout system. In this process, the seller provides the buyer with a unique link to apply for Tabit financing. Once approved, the buyer uploads their invoice to the online portal, and the seller receives payment. In both cases, buyers can check their credit limit beforehand using Tabit’s pre-qualification feature, and sellers are always paid within one business day.
Benefits for Buyers
- As low as 0% interest
- Automated one-time application
- No collateral required as security
- Flexible payment options available, for improved cash flow
Benefits for the sellers
- One-time integration for eCommerce sellers: Tabit integrates with numerous commerce platforms—just add it once and it’s ready to go. Open APIs are available for custom in-house builds.
- No technical setup needed for the invoice solution: simply log in to your portal and send payment links.
- Boost your cash flow: receive payment the next business day for any sales made through Tabit.
- Drive growth: increase order value and purchase frequency.
- Remove risk: Tabit handles all fraud and credit risks.
- Centralized dashboard: manage all your Tabit transactions, track payments, and gain valuable insights on your customers.
Get started with Tabit today
Learn how Tabit can support your business by booking a demo today.