Money Matters

What is invoice factoring? 

Learn all you need to know about invoice factoring, including the benefits and a guide to how it works.

17 March, 20269 min read Share

Many businesses, including yours, likely know the frustration of sending out invoices and getting no response. 

With payment terms typically ranging from 30 to 90 days (the average time period you give customers to pay), it can be tough to manage cash flow whilst covering payroll, utilities, stock, and other operational costs—all whilst striving to grow your business. 

This is where invoice factoring can help. 

Instead of waiting for customers to pay, you can unlock that cash straight away. 

In this guide, we explain how invoice factoring works and help you determine if it’s the right solution for your business. 

Here’s what we’ll cover:

Invoice factoring definition 

Invoice factoring is when you sell your unpaid invoices to a company (called an invoice factoring service), and they give you cash straight away. 

Your credit score stays untouched because you’re selling the invoice, not taking out a loan; however some may still carry out credit checks.  

It’s all about getting the money you’re due immediately instead of waiting for your customers to pay up. 

Perfect for small businesses that need cash to keep things running like clockwork. 

How does invoice factoring work? 

Invoice factoring is not a traditional small business loan. 

Instead, it lets you sell your unpaid invoices to invoice factoring companies at a discount in exchange for immediate payment. 

Invoice factoring services advance you a portion of your invoice’s value—usually up to 90%. 

They then take responsibility for collecting payment from your customer. 

Once your customer pays in full, the remaining balance is sent to you, minus the factoring company’s fee for their services. 

How factoring invoices works in four steps: 

1. You sell your invoice to a factoring company 

2. They advance you a percentage of that invoice 

3. They chase down your customer for payment 

4. Once they collect, they send you the rest, keeping their fee. 

What are the benefits of invoice factoring? 

Now that you understand how invoice factoring works, let’s discuss why it’s a valuable option. 

Faster growth 

Invoice factoring gives you cash immediately, so you can hire more people, stock up on inventory, or take advantage of a new opportunity without stressing over unpaid invoices. 

It is widely used globally and continues to grow as more businesses look for flexible cash-flow solutions. 

Improved cash flow 

You get your money upfront, meaning you can pay your bills, cover payroll, and still have enough left over to keep your business running smoothly. 

Invoice factoring keeps your cash flow statement looking healthy without having to wait around for overdue payments. This makes for a smoother operation. 

Better relationships with customers 

You don’t have to chase down your customers for payments. 

The invoice factoring company handles that for you, so you can focus on keeping interactions friendly with your clients. 

Increased efficiency 

Invoice factoring companies handle collections, leaving you more time to focus on growing your business. 

The professionals handle the tedious tasks, so you can put your energy into making your next step, whether launching a new product, expanding your team, or catching up on paperwork. 

Reduced risk (depending on the agreement) 

With invoice factoring, you get cash upfront without taking on any new debt or doing anything else that might affect your credit score. It’s not a loan—it’s a sale. 

Depending on the agreement, some or all of the credit risk may transfer to the factoring company. In many cases, businesses remain responsible for disputed invoices or customer non-payment outside of insolvency. 
 
In non-recourse factoring, the factoring company typically takes on the risk of customer insolvency, though businesses may still be responsible for disputed invoices or non-payment for other reasons. 

What are the different types of invoice factoring? 

There are different types of invoice factoring, each with its own pros and cons. 

Let’s look at the main ones so you can determine what works best for your business. 

Recourse factoring 

With recourse factoring, if your customer doesn’t pay their invoice, you may have to repay the invoice factoring company for the money they advanced you, which can seem risky. 

However, recourse factoring usually comes with lower fees as you take more risk. 

So, if you’ve got reliable customers, it can be a cheaper way to get cash quickly. 

Non-recourse factoring 

In non-recourse factoring, the risk shifts to the invoice factoring company. 

If your customer doesn’t pay, it’s their problem. 

But it’s worth noting that this peace of mind usually comes with higher fees. 

Spot factoring 

Spot factoring may be the answer if you need cash for a large invoice immediately. 

It lets you factor a single invoice, not your entire ledger. 

Perfect for dealing with a one-off cash crunch without committing long-term. 

Whole ledger factoring 

In contrast to spot factoring, there is whole ledger factoring. 

This means factoring all of your invoices in a full-commitment option. 

If you’ve got slow-paying customers across the board, this might make sense. 

If only a few of your customers tend to cause delays, whole ledger factoring may not be necessary. 

Disclosed factoring 

Disclosed factoring is the more transparent approach. 

Your customers know about the factoring agreement, and they’re instructed to pay the factoring company directly. 

They’ll receive a Notice of Assignment document, so there’s no question of where their payment is going. 

Non-notification factoring 

If you’d rather keep things discreet, non-notification factoring (confidential factoring) keeps your customers in the dark. 

They don’t know you’re working with a factor, and payments still seem like they’re going straight to your business. 

The invoice factoring company acts as an extension of your team, quietly handling everything behind the scenes without telling your clients. 

Invoice factoring example 

Here’s a breakdown of how invoice factoring works, with an example: 

• You’ve sent out a £20,000 invoice to a customer for some of your services. 

• You sell that invoice to a factoring company. They advance you 85% of the total amount, so you get £17,000 upfront. 

• The invoice factoring company takes over and is now chasing down your customer for payment so you can focus on growing your business. 

• The invoice factoring service charges a 6% fee for every 30 days it takes your customer to pay. Since your customer pays within 30 days, that’s a 6% fee on £20,000, which equals £1,200. 

• After your customer pays, the invoice factoring company sends you the remaining 15% of the invoice amount, which is £3,000 minus that £1,200 fee. So, you end up with £1,800. 

When looking at an overdue invoice and considering factoring, remember: you get cash now, and invoice factoring companies handle the rest (at a cost). 

Invoice factoring rates 

Here are a few of the elements that affect the cost when it comes to invoice factoring fees and rates: 

• How much cash you need 

• How reliable your customers are at paying up 

• The size of the invoices and how long they’ve been outstanding 

• Whether you’re factoring all your invoices or just a few 

You’ll typically see either tiered rate structures or daily rate structures. 

With tiered rates, your fee jumps every 10 to 30 days that the invoice remains unpaid. 

On the other hand, daily rates increase slightly each day. 

If you factor in an invoice and it’s unpaid for 42 days, for example, a tiered rate might mean a fee of 2.5%, whilst a daily rate could be around 2.1%. 

Basically, the sooner your customer pays, the less you pay in fees. 

Are factored receivables subject to tax? 

Invoice factoring doesn’t usually change your VAT obligations. You will continue to remain responsible for charging and accounting for VAT on your invoices, while factoring fees are typically treated as an allowable business expense for tax purposes.  

The accounting and tax treatment can vary depending on whether the arrangement is with or without recourse, so you should consult with a tax professional to understand the specific tax implications of invoice factoring. 

Invoice factoring versus invoice financing 

You may have heard the term ‘invoice financing.’ 

You might even have mistaken it for invoice factoring, but they’re different. 

Unlike invoice factoring, invoice financing is a type of borrowing. You’re essentially using your invoices as collateral to secure a loan or credit facility. 

You’re still responsible for collecting payments, and once your customers pay, you must repay the loan plus any additional fees and interest. 

What is a factoring company? 

An invoice factoring company, or just a factor for short, works in this way. 

You get approved, and then you can sell your outstanding invoices to them. 

This means you receive cash immediately and don’t have to wait for long payment terms to be settled. 

The factor reviews your invoices, provides up to 90% of the invoice value, and handles payment collection from your customers. 

They’ll even send them a notice instructing them to pay the factor rather than you. 

Once your customer pays, the factor will send you the remaining invoice amount, minus their fee. 

Streamline business cash flow management with invoice software 

82% of businesses fail due to cash flow issues, which is a huge number. 

Invoice factoring can be a good way to help keep your business in the black. 

But it’s also important to consider your overall invoicing processes, making sure they are as effective as possible in supporting your cash flow. 

By investing in smart invoicing software, you can automate and simplify how you manage invoices, from invoice creation right through to tracking outstanding and incoming payments: 

• No long waits for payments. Sage software speeds up the process with automatic reminders and faster payment options. 

• No manual tracking or errors. The system streamlines invoicing, saving you time and cutting costs. 

• No more manual mistakes. Invoicing software automatically generates and sends accurate invoices, so you get paid easily. 

• Fewer disputes and delays. E-invoicing ensures everything is correct, boosting your credibility. 

• Keep your cash flow steady with on-time invoices and clear payment terms. 

• Manage invoices from anywhere—whether you’re at your desk or on the go. 

FAQs about invoice factoring