More About Factoring
In factoring, your customers’ creditworthiness is critical in determining whether your business qualifies for the service, how much cash you can access, and what it will cost. After all, your customers (known as debtors) are the primary source of repayment.
Understanding how factoring companies evaluate credit can help you qualify more easily, secure higher advance rates, and reduce your fees.
Credit Evaluation Tools Used by Factoring Companies
To assess your customers’ creditworthiness, factoring companies typically rely on commercial credit reporting agencies, including:
- Dun & Bradstreet (D&B)
- Ansonia (an Equifax company)
- LexisNexis
In addition, many factoring companies use credit insurance providers to supplement customer data and sometimes credit-protect invoices. Leading providers include:
- Coface
- Euler Hermes
- Atradius
- Allianz Trade
How Customer Creditworthiness Affects Factoring
Since factors advance funds based on your customers’ invoices, the financial condition and reliability of your customers to pay significantly impact:
- Your eligibility for factoring
- The advance rate you’ll receive
- The fees or discount rate you’ll pay
Factoring companies devote significant time to evaluating your customers’ creditworthiness, as it’s the primary source of repayment.
The Role of Customer Concentration
Credit isn’t the only consideration—customer concentration also plays a significant role. The more revenue concentrated with a single debtor, the higher the risk.
- If a large portion of your receivables come from one customer, that customer’s credit must be exceptionally strong. Disputes, not financial weakness, are often the greater threat in high-concentration scenarios.
- With a low concentration and broad customer mix, your customers with thinner credit histories may still qualify for funding since the risk is diversified.
Advance rates, discount fees, and other structures reflect these differences. Lower concentration generally means lower risk, translating to better terms and a better factoring experience.
Eligibility for Factoring Services
Even financially healthy businesses can be declined for factoring if their customers have poor credit.
Examples:
- Client I – was approved with 10 customers, 8 of whom had Dun & Bradstreet Paydex Scores above 70 and no negative public records.
- Client II – was declined due to 3 key customers with pending lawsuits, delinquent taxes, and frequent late payments.
Factors can be selective when choosing which debtors and invoices to purchase. Several factors can influence their selection process. A factoring company can provide funding even if your customer base includes both creditworthy and marginally creditworthy clients.
Advance Rates & Fees
Advance rates typically range from 70% to 95%, depending on your industry, the credit quality of your customers, and how fast your customers pay. Fees (or discount rates) also vary depending on the above.
Creditworthy customers influence the determination of the advance rate; however, the factoring company’s knowledge and experience in the specific industry often hold more weight than debtor creditworthiness alone. Factors such as dilution, offsets, and competition within the customer’s industry also strongly impact the advance rate.
- Client III – Transportation Company
- Invoices: $50,000
- Debtors: 3 shippers and 3 brokers, all paying within 30–35 days
- Credit scores: All above 95 on Ansonia
- Industry: Well-understood by the factor, low dispute rate, good backup documentation
- Advance rate: 97% | Discount rate: 3.00 Flat Fee
- Client IV – Manufacturing Company
- Invoices: $100,000
- Debtors: 3 major distributors, Dun & Bradstreet Paydex credit scores above 75
- Issues: Occasional disputes, Net 60-day terms
- Industry: Moderate dilution but manageable
- Advance rate: 85% | Discount rate: 1.75% monthly
- Client V – Construction Subcontractor Self-Performing Framing & Drywall
- Invoices: $150,000 (pay-when-paid terms)
- Debtors: 2 creditworthy general contractors with mid-70s credit scores
- Payment: Subject to general contractors receiving payment from the project owner
- Risk: Frequent change orders, pay-on-pay terms, material suppliers
- Industry: High-risk, pay-when-paid clauses and supplier lien rights make collection uncertain
- Advance rate: 70% | Discount rate: 2.50% monthly
- Client VI – Staffing Agency
- Invoices: $200,000
- Debtors: 20+ diversified clients, excellent pay history
- Credit scores: Mostly 80+
- Industry: Stable, well-known to factor, easy to verify with online portals, good payment history
- Advance rate: 92% | Discount rate: 1.25% monthly
As you can see, even with strong credit, industry-specific risks and dilution can impact the advance rate. Conversely, in familiar industries with clean invoices and consistent payment performance, factors may offer more aggressive terms, even if some credit scores are average.
Can One or Two Risky Customers Hurt You?
Yes. A couple of risky accounts can significantly impact your funding agreement.
Potential outcomes:
- Lower overall advance rates
- Higher fees
- Full or partial rejection of your application
High concentration is typically considered a higher risk, regardless of the perceived credit strength. When poor credit is involved, it becomes even more challenging for a factoring company to proceed.
Example:
- Client VII – submitted a $300,000 invoice to a customer with a deteriorating financial condition and a storied credit history. That debtor was excluded. Because the client has 1MM in monthly sales, the total funding availability was reduced by 30%.
Key Factors in Evaluating Customer Credit
Business Credit Reports & Scores
Factoring companies use business credit bureaus like D&B, Experian Business, Equifax, and Ansonia to assess:
- Reported payment history
- Time in business
- If credit utilization and open balances are typical for your industry
- Risk scores (e.g., PAYDEX from D&B)
- Existing loans, lines of credit, and MCAs
- Legal filings (liens, suits, bankruptcies)
- Recent news
- Public SEC filings
Commercial credit reporting agencies may possess comprehensive or limited customer information. Limited information is not necessarily a reason for denial. A factoring company can evaluate the payment and performance history the business provides to assist in making a credit decision. Factoring companies generate revenue only when they purchase invoices, which means they typically seek reasons to approve an advance rather than to decline one.
-
Customer VIII
- PAYDEX: 82 (Pays within terms)
- No delinquent accounts
- 40 Year Time in Business
- 50+ Trade Lines Reporting
- History of lending from National Banks
- Factor’s view: Low risk — high advance rate
-
Customer IX
- PAYDEX: 54 (Often 60+ days late)
- 5 accounts 90+ days past due
- Under 5 years in business
- High-risk lenders identified as creditors
- Factor’s view: High risk — may be excluded
Payment History
Factors favor customers who pay promptly and consistently.
Examples:
- Customer X – terms are net-30, but the customer will often pay within 28 days — This is viewed positively.
- Customer XI – often stretches Net-30 terms and pays in 70+ days— This is viewed as risky.
The best factoring relationships are those where your customers continue to pay in their normal course of business. Despite their reputation, factoring companies are not debt collectors, so most prefer to purchase invoices expected to be paid within their terms.
The first 90–120 days of a factoring relationship are critical. During this time, the factor builds a payment profile to determine whether to:
- Maintain current funding levels
- Rationally increase customer credit (positive customer payment history)
- Reduce or discontinue purchases (negative customer payment history)
Public Records
Factors often check for liens, judgments, lawsuits, or bankruptcies, which can indicate financial instability. They share this information with their customers to help them make more informed decisions about extending credit.
Additionally, some factoring companies use alerts to monitor significant events related to your customers, such as lawsuits, changes in credit ratings, and bankruptcy filings. This practice helps them manage their risk exposure effectively.
Examples:
- Customer XII – has a recent significant tax lien and new litigation — This debtor may be denied.
- Customer XIII – has a clean public record — This debtor clears due diligence.
Industry Risk
Some industries are more prone to payment issues, disputes, or dilution.
Higher-Risk Industries:
- Construction (generally pay-on-pay, additional risk due to subcontractors and material suppliers, often a lack of accurate financial reporting)
- Medical service providers (high dilution, unknown reimbursement rates, claim denials, complex billing, inability to communicate with customers)
Lower-Risk Industries:
- Temporary staffing
- Distribution and manufacturing
- Transportation
Customer Concentration
Heavily relying on one or two customers increases the risk of the factor.
Examples:
- Client XIV – derives 85% of revenue from MegaMart — This may trigger a lower advance or funding cap.
- Client XV – has 20+ customers with no account over 15% — This is viewed as well-diversified.
When evaluating your customer’s creditworthiness, it’s essential to consider various factors beyond those mentioned previously. These factors include the industry in which the customer operates and any downturns that may affect it. Additionally, the nature of your business relationship with the debtor is crucial. Is it a long-standing relationship, or is it a new one?
Tips to Help You Secure Better Invoice Factoring Terms
Work with Creditworthy Customers
- Request business credit reports before extending terms.
- Have customers complete a credit application.
- Use commercial credit reporting services.
- Avoid companies with lawsuits or poor payment histories.
- Don’t assume household names are creditworthy.
- Don’t believe what they tell you.
Encourage On-Time Payments
- Offer discounts (e.g., 1% for 10-day payment)
- Regularly follow up on overdue invoices
Diversify Your Customer Base
- Avoid having one customer exceed 20–30% of your receivables.
Submit Clean Invoices
- Invoice promptly, accurately, and clearly, and follow up to ensure they are in receipt.
- Follow customer-specific invoicing requirements to ensure timely payment.
Request Trade References
- Encourage your customers to maintain positive trade references, as this will improve their credit profile.
Gateway Commercial Finance Offers Complimentary Customer Credit Checks
Before offering terms to a new customer, let us help you assess their creditworthiness. We provide complimentary credit reports, so you can:
- Review payment patterns
- Avoid problem accounts
- Extend terms with confidence
A stronger customer portfolio means:
- Easier qualification
- Higher advance rates
- Lower costs over time
By collaborating with creditworthy customers and choosing an experienced factoring company, you can set your business up for faster approvals, improved cash flow, and reduced costs.
Have questions about your customers' credit?
Call 1-855-424-2955 to learn how we can help you evaluate your customer base and secure the best possible factoring terms. Our team is ready to provide insights, credit checks, and funding solutions tailored to your unique needs.
