Invoice factoring is selling your unpaid invoices to a company for when ready cash, at a discount

When you invoice a customer but have to wait 30, 60, or 90 days to get paid, invoice factoring lets you convert that future payment into cash today. A factoring company buys your invoice for less than its face value — typically 70 to 90 percent of what the customer owes you — and then collects the full amount from your customer when it comes due. You get the cash when ready; the factoring company keeps the difference as their fee.

This is different from a business loan. You are not borrowing money and paying it back with interest. You are selling an asset (the invoice) at a discount. The factoring company takes on the risk that your customer might not pay, and they handle the collection work.

Factoring is most common in industries where payment cycles are long and predictable — trucking, staffing, manufacturing, and construction. It is also used by small businesses that need cash flow to meet payroll or buy inventory before they get paid by their customers.

Key Takeaways

  • Factoring companies typically advance 70 to 90 percent of an invoice's value within 24 to 48 hours, with the remainder paid after your customer settles the invoice.
  • The cost ranges from 1 to 5 percent of the invoice value per month, depending on invoice size, your customer's creditworthiness, and how long payment terms are.
  • You remain responsible for the invoice if your customer disputes the work or refuses to pay, unless you use non-recourse factoring (which costs more).
  • Factoring does not show up as debt on your balance sheet the way a loan does, but it does reduce the cash you ultimately receive from each sale.
  • The factoring company will contact your customer directly to collect payment, which some businesses want to avoid because it signals cash flow problems.

How much factoring actually costs

The fee structure is not a straightforward interest rate. Factoring companies charge a discount fee — a percentage of the invoice value that they keep when they buy it from you. This fee typically ranges from 1 to 5 percent per month, though some companies quote it as an annual percentage rate (APR) that can look much higher.

The actual cost depends on several factors. Invoices under $5,000 usually cost more to factor because the company's processing work is the same regardless of size. Invoices to Fortune 500 companies or government agencies cost less because those customers almost always pay on time. A 90-day payment term costs more than a 30-day term because the factoring company's money is tied up longer.

Example: You invoice a customer for $10,000 with 60-day payment terms. A factoring company offers to buy it at 2.5 percent per month. They advance you $9,750 on day one (the $10,000 minus the first month's fee of $250). When your customer pays the full $10,000 in 60 days, the factoring company keeps another $250 (the second month's fee) and sends you the remaining $9,500. Your total cost is $500, or 5 percent of the invoice value.

Recourse versus non-recourse factoring

With recourse factoring, you may provide the invoice. If your customer does not pay or disputes the charge, the factoring company can demand the money back from you. This is the cheaper option — typically 1 to 3 percent per month — because the factoring company's risk is lower. You keep the collection risk.

With non-recourse factoring, the factoring company absorbs the loss if your customer does not pay. You have no obligation to repay them. This costs more — usually 2 to 5 percent per month — because the factoring company is taking on real risk. Non-recourse factoring is less common and usually only available if your customers are creditworthy and your invoices are large.

Most small businesses use recourse factoring because it is cheaper and easier to set up. Non-recourse is worth considering only if your customer base is unstable or if you operate in an industry with high dispute rates.

The process and funding timeline

Factoring companies move faster than traditional lenders because they are not underwriting your creditworthiness — they are evaluating your customers' ability to pay. The process typically takes three to five business days from process to first advance.

You will need to provide the factoring company with copies of your invoices, proof that the work or goods were delivered, and sometimes a customer list showing payment history. Some companies will ask for your last two years of tax returns or bank statements to verify that your invoices are real and that you have been in business long enough to be reliable.

Once approved, the factoring company sets up an account and you can start submitting invoices. Most will advance funds within 24 to 48 hours of receiving an invoice. You do not have to factor every invoice — you can choose which ones to sell and which ones to wait on.

When factoring makes sense and when it does not

Factoring works best when you have a specific, temporary cash flow problem. You are waiting for a large customer payment and need money to cover payroll this week. You landed a big contract but need inventory upfront. You are growing fast and your receivables are outpacing your cash. In these situations, the cost of factoring is often lower than the cost of missing payroll or losing a growth opportunity.

Factoring makes less sense if your customers pay quickly (within 15 days) or if you have steady cash flow from other sources. The fee eats into your profit margin, and if you are not actually waiting for money, you are paying to speed up something that would happen anyway.

It also does not work well if your customers are price-sensitive or if they object to a third party contacting them about payment. Some customers see a factoring company's collection call as a sign that you are in financial trouble, which can damage the relationship.

How factoring affects your business finances

From an accounting perspective, factoring is cleaner than a loan. When you factor an invoice, you record the sale as complete and the factoring fee as an expense. The transaction does not create a debt liability on your balance sheet. This can make your financial ratios look better to banks or investors.

However, factoring does reduce your net revenue. If you factor $100,000 in invoices at a 3 percent average cost, you net $97,000 instead. Over time, that compounds. A business that factors 50 percent of its invoices at an average 3 percent cost is giving up 1.5 percent of total revenue to factoring fees.

Factoring also does not improve your actual cash position the way a loan does. A loan gives you cash and you repay it over time. Factoring converts future cash into present cash at a discount — you are not gaining money, you are trading time for cost.

Alternatives to invoice factoring

A business line of credit is often cheaper if you have good credit and an established business. You borrow what you need and pay interest only on the amount you use. Interest rates typically run 7 to 12 percent annually, which is lower than factoring fees over time, but you have to may have access to and the lender will review your personal credit.

A merchant cash advance is faster to obtain than factoring but usually more expensive. The lender gives you cash upfront and you repay it by surrendering a percentage of your daily credit card sales. This works only if you process significant card payments.

Trade credit — negotiating longer payment terms with your suppliers — solves the same problem from the other direction. Instead of converting receivables to cash, you delay paying your bills. This requires good relationships with suppliers and does not work if you are already at maximum terms.

A term loan from a bank or online lender is the traditional route. It takes longer to obtain (two to four weeks) but costs less over time if you have decent credit. You borrow a fixed amount and repay it in monthly installments.

Frequently Asked Questions

Will my customers know I am using a factoring company?

Yes. The factoring company will contact your customer directly to collect payment when the invoice is due. Some factoring companies use your company name in their collection calls to minimize the appearance of financial distress, but your customer will eventually realize a third party is involved. If customer relationships are sensitive, ask the factoring company about their collection practices before signing up.

Can I factor invoices to government agencies or large corporations?

Yes, and these are often the easiest invoices to factor because payment is nearly may provide. Government agencies and Fortune 500 companies have long payment cycles (sometimes 60 to 120 days) but almost never default. Factoring companies will usually offer lower fees for these invoices because the risk is minimal.

What happens if a customer disputes an invoice I factored?

With recourse factoring, you are responsible for the dispute. The factoring company will return the invoice to you and you must either resolve the dispute with your customer or repay the advance. With non-recourse factoring, the factoring company absorbs the loss, but they will investigate the dispute before accepting it. Either way, disputes slow down payment.

Is there a minimum invoice size?

Most factoring companies will factor invoices as small as $500 to $1,000, but fees are higher on small invoices because the processing cost is the same. Some companies specialize in small invoices and offer better rates if you factor in volume. Ask about volume discounts if you have many small invoices.

Can I use factoring long-term or is it just for emergencies?

You can use factoring as a permanent part of your cash flow strategy, but the ongoing cost adds up. Some businesses factor 20 to 30 percent of invoices continuously to smooth out payment cycles. Others use it only when they have a temporary cash crunch. The longer you rely on it, the more sense it makes to explore cheaper alternatives like a line of credit.