What Is Invoice Factoring?

Invoice factoring is a form of short-term business financing where a company sells its unpaid invoices to a third party—known as a factor—at a discount. While often lumped in with other types of loans, factoring is technically not a loan. Instead, it’s a financial transaction that converts outstanding invoices into immediate cash.

This method has been used for centuries, particularly in industries with long payment cycles. It remains especially popular in sectors like textiles, logistics, manufacturing, and wholesale distribution—industries where companies often face cash flow challenges while waiting on slow-paying customers.

How Invoice Factoring Works

The factoring process begins when a business submits its unpaid customer invoices to a factoring company. Once approved, the factor typically advances 85% to 95% of the invoice value upfront. The remaining balance—minus a factoring fee—is paid to the business once the customer settles the invoice.

The factor takes on the responsibility of collecting the invoice directly from the customer. The specific terms, including fees and recourse provisions, are determined during the agreement negotiation stage.

Most factoring agreements fall into one of two categories:

• Recourse Factoring: The business agrees to buy back any unpaid invoices. This is more common and generally comes with lower fees.

• Non-recourse Factoring: The factor assumes the risk of non-payment. Because of this increased risk, fees tend to be higher.

What Is a Factoring Company?

A factoring company—sometimes called a factor—is a financial institution or specialized lender that purchases invoices for a discounted rate. Unlike traditional lenders, factoring companies don’t focus on your credit score or business history. Instead, their main concern is the creditworthiness of your customers, since they’re the ones who ultimately pay the invoices.

These companies may be independent finance firms or affiliated with banks. Many operate exclusively online and use digital tools to streamline the application and approval process.

Example of Invoice Factoring

Imagine a restaurant supply business that needs $20,000 to buy equipment for a new client. While it’s owed $20,000 in outstanding customer invoices, those won’t be paid for several weeks.

Rather than wait, the business sells those invoices to a factor for 90% of their value—$18,000 upfront. When the customers pay in full, the factor forwards the remaining $2,000 to the business, minus a 3% fee ($600). The business gets quick cash to keep operations moving without taking on debt or giving up equity.

Why Businesses Use Invoice Factoring

Invoice factoring can help close the cash flow gap between delivering goods or services and receiving payment. It’s especially useful for small and mid-sized businesses that:

• Have limited collateral for traditional loans.

• Experience long invoice payment cycles.

• Need quick working capital to manage payroll, rent, or inventory purchases.

Instead of waiting 30, 60, or even 90 days for payment, businesses can access capital immediately by leveraging outstanding invoices.

Pros and Cons of Invoice Factoring

 Pros

• Fast access to capital without traditional loan underwriting.

• No additional debt added to the balance sheet.

• Helps maintain smooth operations and continue growth.

• Often easier to qualify for than loans or lines of credit.

• Enables businesses to offer net payment terms to clients without compromising cash flow.

 Cons

• Factoring fees can be high, especially with non-recourse agreements.

• The factor may interact directly with your customers, which some businesses prefer to avoid.

• You may be required to buy back unpaid invoices in recourse factoring.

• Not ideal for businesses with unreliable clients or limited invoicing volume.

Who Invoice Factoring Works Best For

Invoice factoring is commonly used in industries that deal with business-to-business (B2B) sales and where delayed payments are the norm. Examples include:

• Manufacturing

• Wholesale and distribution

• Staffing and recruiting agencies

• Logistics and transportation

• Commercial construction

• Textile and apparel

If your business regularly invoices customers on net terms (e.g., Net-30 or Net-60), and you need cash before those invoices are paid, factoring might be a good fit.

How to Qualify for Invoice Factoring

Qualifying for invoice factoring is generally less stringent than traditional financing. However, most factoring companies will review:

• Your clients’ credit histories and payment behavior.

• Your invoicing volume and history.

• Your business’s industry and customer base.

• The age and collectability of the invoices.

Factors want to ensure that the invoices are from creditworthy clients who are likely to pay in full and on time.

To apply, you’ll typically need to provide:

• A list of unpaid invoices.

• Basic financial statements.

• Business and customer contact information.

• Invoice aging reports (to show how long invoices have been outstanding).

The Two Types of Factoring

1. Recourse Factoring

In this agreement, the business agrees to repay the factor if the customer does not pay the invoice. This setup is more common in the U.S. and comes with lower fees. However, it puts the risk of customer default back on the business.

2. Non-recourse Factoring

Here, the factor absorbs the loss if the customer doesn’t pay, assuming the non-payment is due to insolvency or bankruptcy. Because the risk is higher for the factor, these agreements tend to come with higher costs and stricter approval processes.

Is Invoice Factoring Right for Your Business?

Invoice factoring isn’t the right solution for every business, but it can be an excellent option if:

• You issue regular invoices to other businesses.

• You experience frequent cash flow delays due to slow-paying customers.

• You need capital to fund growth, inventory, payroll, or daily operations.

• You don’t qualify for traditional financing or prefer not to take on debt.

Final Thoughts

Invoice factoring offers a time-tested, flexible way for businesses to unlock capital tied up in receivables. While it’s not the cheapest form of financing, it can be a smart tool for improving cash flow without waiting on client payments.

As always, review the agreement terms carefully, especially around fees, recourse, and collection rights. Compare offers from multiple factoring companies, and be sure you’re working with a reputable lender.

If you need capital fast and have solid customer invoices, invoice factoring could be the working capital solution your business is looking for.