Waiting on customers to pay invoices can create cash flow challenges. You may have completed the work or delivered the product, but payment may not arrive for 30, 60, or even 90 days.
Invoice factoring is one way businesses manage that gap. By selling eligible unpaid invoices to a factoring company, a business can access cash sooner instead of waiting for customers to pay.
Understanding how invoice factoring works and what it costs can help you decide whether it fits your business needs.
What is invoice factoring?
Invoice factoring is a cash flow solution where a business sells eligible accounts receivable to a factoring company in exchange for faster access to cash. Instead of waiting for customers to pay outstanding invoices, the business receives an upfront payment from the factor.
Unlike a traditional business loan, invoice factoring is generally structured as a sale of receivables rather than borrowing money against future repayment.
Small business invoice factoring is commonly used by businesses that:
- Invoice other businesses rather than individual customers
- Have reliable customers with established payment histories
- Experience delays between completing work and receiving payment
- Need more predictable cash flow to manage operations
How does invoice factoring work?
Invoice factoring involves three parties:
- The business that issued the invoice
- The customer that owes payment
- The factoring company purchasing the invoice
The process generally looks like this:
- Submit eligible invoices: The business provides unpaid invoices to the factoring company for review.
- Invoice verification: The factor confirms the invoice details and evaluates the customer responsible for payment.
- Receive an advance: If approved, the factoring company provides an upfront percentage of the invoice value to the business.
- Customer pays the factor: The customer sends payment according to the invoice terms.
- Reserve funds are released: The factor deducts its fees and sends the remaining balance to the business.
For example, imagine a business sells a $10,000 invoice to a factoring company. If the factor provides an 80% advance, the business may receive $8,000 upfront. After the customer pays the invoice, the factor deducts its fees and releases the remaining reserve amount.
Advance percentages, fees, and timing vary by agreement.
Recourse vs. non-recourse invoice factoring
Recourse and non-recourse agreements determine who bears the risk if a customer does not pay.
- Recourse factoring: The business remains responsible if a customer does not pay the invoice. Depending on the agreement, the business may need to repurchase the invoice or cover the unpaid amount.
- Non-recourse factoring: The factoring company assumes more responsibility for certain nonpayment situations. However, non-recourse protections are usually limited by contract terms and may not cover every reason an invoice goes unpaid.
Review the agreement carefully to understand your responsibilities.
Invoice factoring vs. invoice financing
Invoice factoring and invoice financing are often discussed together, but they work differently.
- Invoice factoring involves selling unpaid invoices to a factoring company. The factor typically collects payment from the customer.
- Invoice financing involves borrowing against unpaid invoices. The business retains ownership of those invoices and remains responsible for collections.
Both can offer short-term funds to support your cash flow; the choice depends on what your business needs most. Like any financing decision, compare the cost, agreement terms, and effect on your customer relationships before moving forward.
How much does invoice factoring cost?
Invoice factoring rates vary based on several factors, including invoice quality, customer creditworthiness, payment terms, industry, and the factoring agreement.
Common costs may include:
- Advance rate: The percentage of the invoice value provided upfront
- Factor fee or discount fee: The amount charged by the factoring company for providing access to cash
- Service fees: Additional charges that may apply depending on the agreement
- Minimum volume requirements: Contractual requirements to factor a certain amount of invoices
When comparing invoice factoring rates, look beyond the upfront advance rate. A higher advance may not always mean a lower total cost.
To understand how much invoice factoring costs, calculate the total fees paid and compare them with the value of receiving cash earlier. The right choice depends on your cash flow, costs, and how the funds support your business.
Who qualifies for invoice factoring?
Factoring companies often focus on the quality of the invoice and the financial strength of the customer.
They may review:
- Whether invoices are issued to creditworthy businesses
- Invoice age and payment terms
- Customer payment history
- Business legitimacy
- Existing liens or obligations
- Concentration risk
Because the customer paying the invoice is a major part of the evaluation, invoice factoring may be available to some businesses even when the owner’s personal credit history is not the primary factor.
Requirements vary by provider.
Pros and cons of invoice factoring
Like any financing tool, invoice factoring comes with benefits and trade-offs.
Potential benefits of invoice factoring:
- Faster access to cash tied up in unpaid invoices
- More predictable cash flow for businesses with long payment cycles
- Less reliance on customer payment timing
- Potentially less emphasis on the business owner’s personal credit profile
Potential drawbacks of invoice factoring:
- Fees that reduce the total value of invoices collected
- Customer involvement in the payment process
- Contract requirements or minimum factoring commitments
- Less control over some collection activities
A financing option should solve a real business need without creating a new challenge. Review costs and agreement terms carefully before deciding whether factoring fits your business.
When does invoice factoring make sense?
Invoice factoring may make sense for businesses that regularly wait for customers to pay after completing work.
Examples might include:
- A contractor waiting on commercial project payments
- A supplier managing large customer invoices
- A growing business needing cash to purchase additional inventory
- A company covering payroll while waiting for accounts receivable
Factoring may be less useful for businesses that primarily sell directly to customers, have inconsistent invoice payments, or want to avoid involving customers in the payment process. Understanding your cash flow needs can help determine whether factoring or another option is a better fit.
How does factoring affect your customers and collections?
When a business uses invoice factoring, customers may receive a notice of assignment — a legal document directing them to pay the factoring company instead of the original business. The customer relationship can depend on how the factoring company communicates and manages collections.
Before choosing a factoring company, consider:
- How customer communication is handled
- Whether collections match your brand expectations
- How payment issues are resolved
- What information customers receive
How to compare invoice factoring companies
When evaluating factoring companies, the advance rate may not tell the whole story. Important considerations include:
- Advance rate
- Factoring fees
- Recourse or non-recourse terms
- Contract length
- Minimum invoice requirements
- Termination fees
- Reserve release timing
- Industry experience
- Customer service approach
- Lien requirements
Your agreement should clearly explain what you are paying for and what responsibilities your business retains.
Alternatives to invoice factoring for business cash flow
Invoice factoring is one way to manage cash flow, but businesses have other options depending on their needs.
For a defined expense, a working capital loan may provide a lump sum with a structured repayment schedule. A business line of credit may provide access to funds as needed for recurring expenses.
Businesses with revenue-based needs may also explore a merchant cash advance or other forms of revenue-based financing.
The right option depends on your cash flow, financing purpose, and ability to manage the cost. Explore more types of small business loans and business financing with lower credit requirements.
Credibly does not offer invoice factoring. Businesses exploring cash-flow financing options can learn more about products available through Credibly and its funding partners.
Frequently asked questions
Does invoice factoring affect my business or personal credit score?
Credit practices vary by provider. Factoring companies often focus on invoice quality and customer payment history rather than the business owner’s personal credit. Ask the provider how it handles credit reporting.
Can I factor only one invoice instead of all of my receivables?
Some factoring companies allow businesses to factor individual invoices (known as spot factoring), while others require ongoing commitments. Review the agreement requirements before choosing a provider.
What happens if my customer pays an invoice late?
It depends on the factoring agreement. Late payments may affect fees, reserve releases, or your obligations under the contract.
Will my customers know that I am using an invoice factoring company?
In most cases, yes. While there are exceptions, customers typically receive a notice of assignment instructing them to pay the factoring company.
What happens if a customer never pays a factored invoice?
It depends on whether the agreement is recourse or non-recourse and the reason the invoice remains unpaid. In a recourse agreement, your business may be responsible for the unpaid amount.
Can I factor an invoice that is already overdue?
Some providers may consider overdue invoices, depending on the invoice details and agreement terms, but there are no guarantees.
Can a startup use invoice factoring before it has a long credit history?
Some startups use this strategy. Newer businesses may qualify if they have eligible invoices from reliable customers.
Can I stop factoring once my cash flow improves?
Some agreements allow businesses to stop factoring after meeting certain requirements. Review contract terms before signing.
How quickly can I receive cash after submitting an eligible invoice?
Factors may provide cash within a few business days of receiving an eligible invoice, but timing varies by the provider and agreement terms.
What should I review in a factoring agreement before I sign it?
Review advance rates, fees, recourse terms, customer payment requirements, contract length, termination provisions, and any other obligations.
