What is Invoice Factoring?
Learn what invoice factoring is, how selling your receivables works, and when factoring makes sense for B2B businesses with cash flow gaps.
Invoice factoring is a type of financing where a business sells its unpaid invoices (accounts receivable) to a factoring company at a discount in exchange for immediate cash. Instead of waiting 30, 60, or 90 days for customers to pay, you get most of the invoice value right away.
How Invoice Factoring Works
The typical factoring process:
- Step 1: You deliver goods or services to your customer and issue an invoice
- Step 2: You sell the invoice to a factoring company, which advances you 70-90% of the invoice value immediately
- Step 3: The factor collects payment directly from your customer
- Step 4: When your customer pays, the factor sends you the remaining balance minus their fee
Example
You factor a $10,000 invoice. The factor advances you $8,500 (85%) immediately. When your customer pays, the factor sends you the remaining $1,500 minus a 3% fee ($300). You net $9,700 but received most of it immediately.
Factoring Fees
Factoring companies typically charge:
- Factoring fee (discount rate): 1-5% of the invoice value, often charged per 30-day period
- Advance rate: Typically 70-90% of invoice value upfront
- Reserve: The held-back portion (10-30%), released after customer payment
- Additional fees: Sometimes invoice processing, ACH, or monthly minimums
Recourse vs. Non-Recourse
There are two types of factoring arrangements:
- Recourse factoring: If your customer does not pay, you must buy back the invoice or replace it. Lower fees but more risk to you.
- Non-recourse factoring: The factor absorbs the loss if your customer does not pay. Higher fees but protects you from bad debt.
When Factoring Makes Sense
Invoice factoring is often a good fit when:
- You sell to other businesses (B2B) on payment terms
- Your customers are creditworthy but pay slowly
- You have cash flow gaps due to long payment cycles
- You cannot qualify for traditional loans due to credit or time in business
- Growth is straining your working capital
Factoring vs. Invoice Financing
With factoring, you sell your invoices and the factor collects from your customers (they know you are factoring). With invoice financing, you borrow against your invoices but still collect payment yourself (customers may not know).
Factoring is simpler but involves your customers directly. Invoice financing maintains customer relationships but typically requires better credit.
Before factoring, consider how your customers will perceive it. Most business customers are familiar with factoring, but communicate proactively about payment instructions.
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Read more →Important Disclosure
Not Financial Advice: The information provided in this article is for general informational purposes only and does not constitute financial, legal, or professional advice. You should consult with qualified professionals before making any financial decisions.
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