What is invoice factoring? 

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 suppliers to pay), it can be tough to manage cash flow while covering payroll, utilities, inventory, and other operational costs—all while striving to grow your business. 

This is where invoice factoring can help.

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

Your credit score stays untouched as you’re selling the invoice, not taking out a loan.

This is also sometimes referred to as accounts receivable financing.

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.

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.

Plus, with the global invoice factoring market valued at an immense $2,740.47 billion in 2022 and expected to grow at a CAGR of 8.16% by 2032, it’s clear more companies are jumping on board to fuel their growth.

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 big move, whether launching a new product, expanding your team, or catching up on paperwork.

Limited risk 

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.

So, no need to worry about repayment terms, interest rates, or your credit taking a hit.

Plus, the invoice factoring company is responsible for collecting from your customers.

If a customer doesn’t pay, it’s their problem, not yours. You don’t have to deal with the stress or the risk.

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 figure out 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 fast.

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 just one invoice, not your whole 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.
• At the end of the process, you have $18,800 from your original $20,000 invoice, and your APR is around 42.35%.

When looking at a past due 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 a little bit every single 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%, while 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 taxes?

Yes, factored receivables are subject to taxes. When you sell your receivables through invoice factoring it is considered a sale of assets.

The income received from the invoice factoring company is generally taxable and should be reported as revenue. 

The discount or invoice factoring fees the service charges may also have tax implications, potentially affecting your overall tax liability.

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 putting your invoices up as collateral to get a loan or line of credit.

You’re still responsible for chasing down payments, and when your customers pay, you need to repay the loan plus any extra fees and interest.

What is a factoring company?

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

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

This means you get cash immediately and don’t have to wait for long payment terms to wrap up.

The factor checks your invoices, gives you up to 90% of the invoice value, and then handles collecting payments from your customers.

They’ll even send them a notice saying they should pay the factor instead of you.

Once your customer pays, the factor sends 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 green.

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

How much does it cost to factor invoices?

It varies, but you can expect fees between 1-5% of the invoice amount.

Is invoice factoring regulated?

Yes. Invoice factoring companies are subject to certain regulations.

They’ve got to follow federal and state rules to ensure fair play.

What are the disadvantages of invoice factoring?

You’re giving up a chunk of your invoice value.

Plus, you might have to deal with fees and potential strain on customer relationships if they don’t like dealing with a third party.

What is the difference between invoice factoring and invoice discounting?

Invoice factoring means the factoring company handles collections and takes over the invoice.

Invoice discounting lets you keep control of collections, but you’re still getting an advance on your invoices.

When should a business use invoice factoring?

If you need cash fast and can’t wait for your customers to pay, invoice factoring could be a good option to consider.