Invoice Factoring: A Simple Guide to Getting Paid Faster

What is invoice factoring?

Invoice factoring is a financing arrangement where a business sells its unpaid invoices to a third-party lender (a factor) at a discount in exchange for immediate cash. The factor then takes over responsibility for collecting payment from the customer.

How it works

Most factoring arrangements follow these steps:

• You deliver goods or services and issue an invoice to your customer.
• You submit the invoice to the factor.
• The factor advances a large portion of the invoice value (the advance rate), often 70–90%.
• The factor holds a reserve of the remaining amount as protection against nonpayment.
• When the customer pays the invoice, the factor collects the payment, deducts its fees, and remits the rest to you.

The factor may also perform credit checks on your invoiced customers and provides some level of credit management support. Factoring can be with recourse (you are liable if the customer doesn’t pay) or non-recourse (the factor bears more of the risk, usually with higher fees).

Key terms to know

• Advance rate: the upfront percentage of the invoice value the factor pays you.
• Reserve: the portion of the invoice value held by the factor until payment is received.
• Fees/discount rate: the cost charged by the factor for its service, often expressed as a percentage of the invoice value or as a discount rate for the term.
• Recourse vs non-recourse: who bears the risk if the customer doesn’t pay.
• Underwriting: the factor’s review of the customer’s credit and the seller’s invoices.

Pros and cons

• Pros: Faster access to cash, helps smooth cash flow, no need for traditional collateral, often includes back-office support like invoice collection.
• Cons: Can be more expensive than some other financing, involves your customers in the financing arrangement, terms may require ongoing use and can affect customer relationships.

When to consider factoring

• You have customers with long payment terms or slow pay.
• You need to bridge cash flow during growth or seasonal cycles.
• You prefer a financing option tied to invoices rather than a traditional loan.

How to choose a factoring partner

• Speed and reliability of funding.
• Transparent and reasonable fees.
• Advance rate and reserve terms.
• Credit support and industry fit.
• Contract terms, notice periods, and customer experience.

Typical costs and terms

• Advance rates commonly range from about 70% to 90% of the invoice value.
• Fees/discounts typically range from roughly 0.5% to several percent of the invoice value per 30–90 days, depending on risk and term length.
• The total annualized cost varies by industry, customer credit quality, and term length.

Note: Costs can add up over time, so compare offers and read the contract carefully.

Alternatives

• Lines of credit or business credit cards.
• Traditional bank loans or SBA-backed financing.
• Supplier or supply chain finance programs.
• Other cash flow tools like short-term loans or credit facilities.

A simple example

Invoice value: 10,000 Advance rate: 85% -> upfront cash: 8,500 Reserve held: 1,500 Fee (discount rate): 2% of invoice value = 200

When the customer pays 10,000 to the factor:

• The fee is collected from the reserve, and the reserve is released.
• Net to you from this invoice: 8,500 upfront plus 1,300 (reserve release after deducting the fee) = 9,800.

This illustrates how the timing and costs affect cash flow.