Understanding contract vs. spot invoice factoring


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Ask a Lender
September 19, 2017


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Key Points

Contract vs. spot invoice factoring

  • Contract factoring is the sale of some or all invoices to a factor company.
  • Spot factoring is the sale of a single invoice to a factor company.
  • Selective factoring involves a few specific invoices or clients to factor.
  • Contract factoring is less flexible for the business but carries lower fees.
  • Spot or selective factoring is more expensive but more convenient for the invoice seller.

As a small business owner, steady cash flow is your lifeblood. If you’ve struggled to qualify for a conventional business loan and are thinking about invoice factoring, a primary consideration will be how much money you need, and consequently how many invoices you want to sell. This amount dictates whether you should pursue a contract, spot or selective factoring arrangement.

Contract factoring

Invoice factoring traditionally takes the form of contract factoring. This is when a business agrees to sell — all or a minimum number or percentage of — its invoices to a factor company for a set period of time, usually six months to one year.

Getting approved, setting up an account and getting cash in hand typically takes between two and 10 days. While there are few stringent qualification requirements for the business selling the invoices, the factor will take time to do its due diligence and run the credit scores of your clients whose invoices you aim to sell. You will need to complete paperwork to establish the payment arrangement and associated fees. You should also consider informing your clients of the sale through a notice of assignment.

Contract factoring carries lower fees compared to spot or selective factoring, as the factor company is entering a long-term arrangement with the rights to a set amount — if not all — of your invoices. It is also the least flexible arrangement for your business, given the commitment to provide future invoices to the factor. As the factor will take over all invoice management and billing, it’s wise to ensure the factor company you work with is professional and reliable to avoid straining client relationships.

Contract factoring can be useful for a company that requires a financing mechanism similar to a business line of credit. Cash flow problems can be a continuous concern for industries that traditionally extend long payment periods to clients or face seasonal ups and downs in business. For example, contracts in the transportation and construction industry — which together account for 43.7 percent of invoice factoring in the U.S., according to the International Factoring Association — sometimes are not paid for up to three months from the date of service or until a project is completed. Entering into a longer-term contract factoring arrangement can help bridge this payment gap and ensure companies continue to make payroll and purchase necessary materials, year-round.

Spot and selective factoring

Spot factoring is the sale of a single invoice to a factor company at a discount. This arrangement is much more flexible for a business and can typically fund within days.

Spot factoring, however, carries higher rates compared to contract factoring, as the factor company must do the same due diligence and underwriting assessments for just one invoice that it would for a long-term contract factoring arrangement. The return on time invested is lower, thus the higher fees. Furthermore, factor companies deduct a percentage discount from the invoice total as their fee, so factoring a sole invoice is less lucrative.

Selective — or partial — factoring allows a business to choose a few specific invoices or clients to factor. It falls between spot and contract factoring both in flexibility and cost. Several online invoice factoring companies specialize in selective factoring, funding invoices within a few days.

Spot and selective factoring can be more complicated for the invoice seller, particularly if you are only factoring a few of several invoices from the same client. The client also needs clarity on who to pay for which invoice.

Spot and selective factoring works best for businesses that need one-off financing for an unexpected expense, be it an opportunity — such as making an acquisition or fulfilling a large, surprise contract — or an emergency situation. Whatever the scenario, compare factor companies to ensure that the cost of factoring does not outweigh the benefits of quick cash.

Which invoices should I factor?

While the factor company will run a credit check on your clients, it is also wise to only factor invoices that you are confident will be paid. Depending on whether you have a recourse or nonrecourse arrangement, you could incur hefty charges if your client fails to pay. Government contracts are often good invoices to factor, as they are generally reliable — albeit slow — to pay.

Invoice factoring entrusts some of your business processes and client relationships to a third-party factor company. As such, it is important to have clarity on how many and which invoices you will factor to maintain control of your finances and business relationships.


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