What Is Invoice Factoring and How Does It Work?
📷 Kindel Media · Pexels✦ Key takeaways
- You sell your unpaid invoices to a finance company for immediate cash (at a discount).
- You typically get 70–90% upfront, the rest after the customer pays, minus fees.
- Faster than a bank loan but more expensive — good for temporary cash-flow gaps.
A common problem for small businesses: you delivered a service or product and issued an invoice with 30- or 60-day terms, but you need money now for payroll or materials. This is where invoice factoring comes in: you sell your unpaid invoices to a specialized company (a factor) and get most of their value in cash immediately.
The idea is that you don't wait for the customer — the finance company gives you the cash and takes over collecting the invoice from your client. In return, it charges a fee on the amount.
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How it works, step by step
First, you sell to your customer and issue an invoice. Second, you sell the invoice to the factor, which gives you an advance of usually 70–90% of its value. Third, the customer pays the invoice to the factor at its due date. Fourth, the factor pays you the rest (the reserve) minus its fee (typically 1–5% of the invoice value).
A worked example
| Item | Value |
|---|---|
| Invoice value | $10,000 |
| Advance (85%) | $8,500 immediately |
| Factoring fee (3%) | $300 |
| Paid after collection | $1,200 |
| Total you received | $9,700 |
There are two types: recourse — if the customer doesn't pay, you are responsible for repaying, and it's cheaper; and non-recourse — the factor absorbs the non-payment risk, but the fees are higher.
When it fits, and alternatives
Invoice factoring is faster than a bank loan and depends on your customers' quality rather than your credit history, so it suits growing companies with a temporary cash gap. But it is more expensive than traditional financing, so it's not a permanent fix. Alternatives include a bank line of credit, invoice financing (using invoices as collateral instead of selling them), or improving payment terms with customers. As with any financing decision, compare the true cost and consult a financial professional.