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What is Invoice Factoring and How Does it Work?

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Content was accurate at the time of publication.

Invoice factoring enables you to convert unpaid invoices into cash for your business. Cash-flow issues are one of the most common problems small businesses face, and invoice factoring could be a potential solution.

At the same time, invoice factoring can be confusing to understand at first — and that’s especially important since it works differently from most other business financing products. We’ll explain what you need to know if you’re considering it for your business.

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What is invoice factoring?

Invoice factoring is the process of selling your unpaid invoices so you can get cash now to better cover short-term gaps in your cash flow. It’s also known by various names as “accounts receivable factoring” or “factoring receivables.”

In general, invoice factoring works like this: You submit an approved invoice to your factoring company, and they pay you an advance on that invoice immediately, ranging from 70% to 90% of the total invoice amount. Your customer pays the factoring company, after which the factor will send you the remainder of the invoice minus its own fees to close out the transaction.

Is invoice factoring a business loan?

Invoice factoring is often lumped in with business loans and business lines of credit but it’s important to know that it’s not the same thing, even if the end effect is similar. It’s a cash advance and an alternative way to get money when you need it.

Invoice factoring isn’t creating a debt: you’re simply selling the collection rights to a debt you already own — unpaid invoices — in exchange for faster access to those funds. That’s why your customer’s credit and payment history matters more than your own credit.

How invoice factoring works

Invoice factoring companies may vary in how they do business, but in general, here’s how the process works:

  • You apply for invoice factoring. The factoring company will review your clients and draw up an agreement for an ongoing relationship allowing you to submit invoices.
  • You invoice the client. After you complete work or sell your product, you’ll send your invoices to your client.
  • You submit the invoice to a factoring company. You’ll submit those same invoices again to the factoring company, usually via an online portal.
  • The factoring company advances you the funds. You’ll receive the funds via ACH or wire transfer based on the advance rate in your contract, typically 70% to 90%.
  • Your client pays the factoring company. You’ll need to notify your client or have them sign an agreement so they understand they now pay the factoring company, not you.
  • The factoring company sends you the remainder, after fees. When your client pays the factoring company, they’ll send you the rest of the invoice minus their fee.

Invoice factoring example

When you submit an invoice for factoring, the factoring company won’t pay you the full amount of the invoice at once. Instead, you’ll receive two separate payments, starting with the upfront payment based on your advance rate and a follow-up payment later after your client pays the invoice factoring company.

How much does invoice factoring cost? It depends on the factor rate, also known as the “factoring fee” or “discount rate.” When the factoring company sends you the second payment, they’ll discount it by this pre-set fee.

Here’s an example of how it works:

Invoice value$10,0000
Advance rate90%
Factoring rate (discount rate)2%
Upfront cash payment$9,000
Remainder payment$800
Total cost$200

In this example, you charged a customer $10,000 and agreed to accept $9,800 from an invoice factoring company in order to receive most of the funds upfront, rather than waiting until your client pays later.

Pros and cons of invoice factoring


 Smooth out cash flow: Receive payment in hours or days, instead of weeks or months. 

 Free up time: You won’t spend valuable office time hunting down clients for unpaid invoices. 

 Easier to qualify: Invoice factoring relies on your customer’s credit, not your own, making it a viable option for businesses with bad credit.

 Non-recourse factoring: With this option, you’ll get funds even if your customer never pays their invoice.

 Shady companies: Good factors do exist, but there are many bad ones that rely on an opaque structure.

 Lower profit margins: Paying a 2% factor fee means your business is 2% less profitable.

 Recourse factoring: The factor can demand you pay any unpaid invoices with this option, which can throw a wrench in your plans.

 Hidden costs: Companies frequently charge extra fees that aren’t advertised openly on their websites.

 Lack of customer control: Customers may be confused, and you have no say in how the factor collects that invoice from your customer. 

 Doesn’t build business credit: You can use traditional financing to build credit, but invoice factors don’t report to credit bureaus. 

How to qualify for invoice factoring

One of the reasons why invoice factoring is so popular is because it’s easier to get for many business owners compared with applying for a business loan. As long as you operate a business that sends out invoices (as opposed to making mostly retail sales), you may be eligible. Here are the main factors invoice factoring companies will consider:

  • Invoice history: If you consistently work with a few companies that always pay their invoices on time (even if it takes a while, such as on a net-90 billing cycle), you’re a good candidate.
  • Credit score: Invoice factoring companies may look at your credit score, but your customer’s credit matters more since those invoices are what you’re selling.
  • Minimum monthly revenue: You may be required to submit a certain volume of invoices for factoring each month, either across all your customers or from specific pre-approved customers.
  • Time in business: The longer you’ve been in business, the easier it is to show you’re able to roll with the business punches, and you may be able to point to a longer invoice history with certain customers too.

Invoice factoring vs. invoice financing

Invoice factoring is often confused with invoice financing, but they’re not the same thing. Invoice factoring involves selling your unpaid invoices to a factor who becomes the owner of the debt and handles repayment, similar to a debt collector.

Invoice financing (or accounts receivables financing) involves using your invoices as collateral to get a secured business loan that you’ll repay when you’re paid. With invoice financing, you stay in the driver’s seat for handling repayment and customer contact.

Invoice factoring alternatives

Invoice factoring isn’t right for everyone, so be sure to compare your other options:

Short-term business loan

A short-term business loan offers a lump-sum cashout similar to invoice factoring, but it’s not an advance on future sales. Instead, you’ll repay the business term loan over a few months or years with steady payments. Getting approved can be a tougher and lengthier process, but they’re a cheaper option and can help you build credit.

Business credit cards

You can use a small business credit card to make everyday business purchases and sometimes earn valuable rewards. It’s best to pay them off each month, but if you can’t, you can use them as financing just as you can with a personal credit card.

Business line of credit

Similar to a credit card, a business line of credit allows you to borrow large sums of money (called a “draw”) as needed. They may also be harder to qualify for, especially for new or credit-challenged businesses.

Merchant cash advance

Similar to invoice factoring, a merchant cash advance offers upfront funds in exchange for a percentage of your credit card receipts until the financed amount is repaid, plus a pre-set fee. It’s also easier to qualify for many business owners and is better geared for retail shops, but is typically very expensive.

Small business grants

These are offered sporadically by non-profit organizations and governments, often making them difficult to find when you’re in a pinch. If you qualify for a small business grant, you typically won’t need to repay it, though — it’s generally considered free money, an investment in your business.


The SBA works with lenders to offer a popular microloan program offering up to $50,000 for various small-business borrowing needs. It’s a good option to get needed capital with long repayment timelines, but SBA microloans come with a funding time of up to three months. This means that it’s not a good option to cover immediate cash-flow gaps.

How to choose the best invoice factoring companies

Here are some important factors to consider when you’re shopping for invoice factoring companies:

  • Time to funding: Some companies process your advance faster than others, particularly ones that use automated processes with wire transfers.
  • Required minimums: Factors may require you to factor all invoices with them, or only invoices from certain customers, or possibly just a general dollar minimum each month.
  • Industry expertise: Factors commonly specialize in certain industries such as trucking, which may offer you certain advantages over a more general factoring company.
  • Advance rate: A higher advance rate means fewer shortfalls in your cash flow — often the entire point of using invoice factoring in the first place.
  • Discount rate or fees: Make sure you know all fees before you sign on the dotted line on your financing agreement, and consider how they might impact your business’s profitability.
  • Recourse policy: Recourse lenders require you to cover any invoices left unpaid, but may be less expensive to work with. Non-recourse lenders may be more expensive but won’t require you to cover unpaid invoices.



Some finance companies specialize in offering invoice factoring, and a few companies niche down even further by working with specific industries since they may be more familiar with the ins and outs of how payment cycles work. Factoring companies (also known as “factors”) aren’t as tightly regulated as the consumer financial market, so the way each company works can vary a lot.

You, the business owner submitting your unpaid invoices for immediate payment, will be the one paying the factoring fee. You pay this fee when the factoring company withholds the discount rate (or factor fee) from the final remainder payment after your customer pays their invoice to the factoring company.

It depends on the factoring company. Some may require that you factor all invoices, while others only require you to factor invoices for certain customers. Some factoring companies may instead only require a certain monthly dollar volume of invoices.

You’ll receive the first advance payment within hours or a business day or two, depending on the factoring company. After your customers pay their invoice to the factoring company — however long that takes — you’ll receive your second and final payment. You may receive this payment immediately or as a part of a batch payment, depending on the factor’s policies.

The discount rate for invoice factoring typically runs between 1% and 6% of your invoice amount. Companies commonly charge various other fees, too, which can drive your costs up further.

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