Invoice factoring: turning unpaid invoices into cash
If you sell to other businesses and wait 30, 60 or 90 days to get paid, factoring lets you collect most of that money now. The cost depends heavily on how the fee is structured and how quickly your customers pay. This guide walks through both so you can price an offer before you commit.
- Typical advance
- Often 70% to 90% of the invoice value up front
- Typical fee
- Often 1% to 5% of the invoice, depending on how long it stays open
- Repayment
- Your customer pays the invoice; you do not make monthly payments
- Approval leans on
- Your customers' payment history more than your own credit
- Speed
- Setup can take days to a couple of weeks; later invoices often fund faster
- Best for
- B2B companies with creditworthy customers on net-30 to net-90 terms
How invoice factoring works
With factoring, you sell your unpaid invoices to a factoring company. It pays you part of each invoice right away, waits for your customer to pay, then sends you the rest minus its fee. The sequence usually looks like this:
- You deliver the work and invoice your customer as normal, with payment instructions pointing to the factor.
- The factor verifies the invoice, often by confirming with your customer that the goods or services were received.
- You receive the advance, a set percentage of the invoice value.
- Your customer pays the factor on its usual schedule.
- The factor releases the remainder, sometimes called the reserve or rebate, after deducting its fee.
Because the factor relies mainly on your customer to pay, a young business can sometimes qualify when a bank would decline. The flip side is that the factor cares a great deal about who your customers are. Invoices to large, reliable payers are easy to factor. Invoices to slow or shaky payers may be refused or priced higher.
Factoring vs invoice financing
The two terms are often used interchangeably, but they describe different arrangements. In factoring, the factor buys the invoices, usually collects from your customer directly, and your customer typically knows. In invoice financing (sometimes called accounts receivable financing), you borrow against your invoices, you keep collecting from customers yourself, and you repay the lender when they pay you.
| Invoice factoring | Invoice financing | |
|---|---|---|
| What happens to the invoice | Sold to the factor | Used as collateral for a loan or line |
| Who collects from your customer | Usually the factor | Usually you |
| Does your customer know | Usually yes (notification) | Often no |
| What approval leans on | Your customers' credit | Your customers and your own financials |
| How you pay it back | Customer payment settles it | You repay when the customer pays you |
Advance rates and fee structures
Two numbers drive the cost: the advance rate, which decides how much cash you get up front, and the factoring fee, which decides what you give up. Fees tend to come in two shapes.
- Flat fee. One percentage of the invoice, charged whether your customer pays in 10 days or 60. Simple, but a quick payer costs the same as a slow one.
- Tiered or time-based fee. A starting percentage for an initial period, then an extra charge for each additional week or 10-day block the invoice stays unpaid. Cheaper when customers pay promptly, more expensive when they drag. Ask whether a partial period counts as a full one; it usually does.
Here is how the same invoice plays out under each. Say you factor a $40,000 invoice at an 85% advance, so you receive $34,000 up front. Compare a flat 3% fee with a tiered fee of 1.5% for the first 30 days plus 0.5% for each further 10 days or part of 10 days.
| Customer pays after… | Flat 3%: fee / rebate | Tiered: fee / rebate | Rough annualized cost (flat vs tiered) |
|---|---|---|---|
| 20 days | $1,200 / $4,800 | $600 / $5,400 | about 64% vs about 32% |
| 45 days | $1,200 / $4,800 | $1,000 / $5,000 | about 29% vs about 24% |
| 75 days | $1,200 / $4,800 | $1,600 / $4,400 | about 17% vs about 23% |
The rough annualized figure divides the fee by the $34,000 you actually received and scales it to a year. It is an estimate, not a formal APR, but it makes the pattern clear. Fast payers make flat fees look expensive; slow payers make tiered fees climb. Before you choose, look at how many days your customers really take to pay, not the terms printed on the invoice. Other fees, such as application, due-diligence, wire, credit-check or monthly service charges, come on top and raise the real cost.
Price factoring in dollars per invoice, based on your customers' actual payment days. A low headline rate can still cost more if the fee clock keeps running.
Recourse vs non-recourse
This question decides who absorbs the loss if a customer never pays.
- Recourse factoring means you must buy back or replace an invoice that goes unpaid past a set point, often 60 to 90 days. It is the most common form and usually carries lower fees.
- Non-recourse factoring means the factor takes the loss in some situations. Read the definition closely: it is often limited to a customer's documented insolvency or bankruptcy, not to a customer who simply disputes the work or pays late. Fees are usually higher.
Non-recourse is not credit insurance against every kind of non-payment. If the contract defines it narrowly, you may still be on the hook for most real-world problems.
What your customers will see
Most factoring is notification factoring. Your customer is told to send payment to the factor, often through a notice of assignment and new remittance details on your invoices. The factor may also call to verify invoices. Large companies deal with factors routinely; some smaller customers may ask questions. A few providers offer non-notification arrangements, usually to businesses with stronger financials. Ask how the factor contacts customers and handles late payers.
When factoring fits, and when it doesn't
Factoring tends to suit you when:
- you sell to other businesses or government agencies on net-30, net-60 or longer terms;
- your customers are reliable payers, even if your own credit or time in business is limited;
- you are growing faster than your cash allows, for example in trucking, staffing or wholesale;
- your margins can comfortably absorb a few percent per invoice.
It is usually a poor fit when you sell mainly to consumers, when your invoices are often disputed or tied to unfinished work, when margins are thin, or when the cash gap is really an ongoing loss rather than a timing issue. If your need is general and not tied to receivables, compare a business line of credit or a working capital loan. If you are weighing factoring against a merchant cash advance, our true-cost calculator helps you put the advance on the same annual footing.
Contract terms to check before you sign
- Monthly minimums. Some agreements require you to factor a minimum dollar volume each month, with a penalty or fee if you fall short. A slow month can mean paying for invoices you never factored.
- Term length and auto-renewal. Watch for 12- or 24-month commitments that renew automatically unless you give notice inside a narrow window.
- Termination fees. Find out what it costs to leave early and what notice is required.
- Whole-ledger requirements. Some factors want every invoice, not just the ones you choose. Spot factoring, where you pick individual invoices, usually costs more per invoice but avoids that lock-in.
- Fee schedule. Get every fee in writing, including how the fee clock counts days and partial periods.
- Recourse period. How many days before you must buy back an unpaid invoice, and how the buyback is charged.
- Reserve release timing. When the rebate is paid, and whether the factor can hold it to cover other invoices.
- Liens and guarantees. A factor usually files a UCC-1 lien, sometimes on all business assets, and many ask for a personal guarantee covering fraud or breach of warranties.