If customers take 30, 60 or 90 days to pay, you can be profitable on paper and still short of cash. Invoice factoring and related forms of invoice finance turn unpaid invoices into cash now, for a fee. They can be useful — and expensive. This guide explains how they work so you can compare offers sensibly.
This is general information, not financial or legal advice. Terms vary widely between providers and countries; read agreements carefully and consider independent advice.
The main types of invoice finance
| Type | How it works | Who collects from the customer? | Customer knows? |
|---|---|---|---|
| Factoring | You sell invoices to a factor, who advances most of the value and collects payment | The factor | Usually yes |
| Invoice discounting | You borrow against your invoices; you keep collecting | You | Usually no (confidential) |
| Selective / spot factoring | Factor individual invoices rather than your whole ledger | Usually the factor | Usually yes |
| Invoice financing platforms | Online lenders advance against specific invoices, often with integrations to accounting software | Varies | Varies |
How factoring works, step by step
- You deliver goods or services and issue an invoice to your customer as usual.
- You submit the invoice to the factor, who checks it and your customer’s creditworthiness.
- The factor advances a percentage of the invoice value — often a large majority of it — within a day or two.
- Your customer pays the factor (the invoice carries the factor’s payment details or an assignment notice).
- The factor pays you the balance, minus its fees.
Worked example
| Item | Amount |
|---|---|
| Invoice value | $10,000 |
| Advance (85%, illustrative) | $8,500 paid to you now |
| Customer pays the factor after | 45 days |
| Factoring fee (illustrative: 1.5% per 30 days → 2.25% for 45 days) | $225 |
| Balance released to you | $10,000 − $8,500 − $225 = $1,275 |
| Total received | $9,775 |
That $225 fee to receive $8,500 roughly 45 days early works out at roughly 2.6% of the money advanced for 45 days — around 21% a year annualised — before any other fees. The exact effective rate depends on the fee structure, so always calculate it for your own numbers.
How fees are structured
Providers price in different ways, which makes comparison tricky:
- Discount or factoring fee — a percentage of the invoice value, often charged per period (e.g. per 30 days or per week) until the customer pays
- Flat fee — a single percentage regardless of how long payment takes (watch for the maximum period it covers)
- Service or administration fees — monthly minimums, per-invoice fees, setup fees
- Interest on the advance — common in invoice discounting, similar to an overdraft
- Other charges — credit checks, bank transfers, early termination, minimum volume commitments
Tip: for any offer, add up all fees for a typical invoice and payment time, then compare the total cost to what you’d receive. A low headline rate with high minimums can be the most expensive option.
Recourse vs. non-recourse
- Recourse factoring — if your customer doesn’t pay, you have to repay the advance (or replace the invoice). Cheaper, because you keep the credit risk.
- Non-recourse factoring — the factor bears the risk of customer insolvency (usually not of disputes). More expensive, often with conditions and credit limits per customer.
Read the definition of non-recourse carefully: it rarely covers a customer refusing to pay because of a dispute about your work.
Pros
- Fast access to cash tied up in receivables
- Funding grows with your sales, unlike a fixed loan
- Approval depends largely on your customers’ creditworthiness, which can help young businesses
- With factoring, the provider handles collections (useful if you have no credit control staff)
Cons and risks
- Cost — often significantly more expensive than a bank overdraft or loan
- Customer relationship — customers will usually know you factor, and the factor’s collection style reflects on you
- Contracts — some require you to factor your whole ledger, impose minimum volumes, or have long notice periods and exit fees
- Concentration limits — the factor may cap how much it will fund against any one customer
- Disputes — disputed invoices are usually excluded or charged back to you
- Not suitable for consumer invoices or very small invoice volumes
Before you sign: questions to ask
- What percentage is advanced, and when is the balance paid?
- What are all the fees, and what’s the total cost on a typical invoice?
- Recourse or non-recourse? What exactly is covered?
- Do I have to factor all invoices or can I choose?
- What’s the minimum term, notice period and exit fee?
- How will you contact my customers, and can I see your collection process?
- What happens to disputed or overdue invoices?
Alternatives worth trying first
Factoring solves a cash-flow gap — but it’s often cheaper to narrow the gap itself:
- Shorter payment terms and clear due dates (payment terms explained)
- Deposits and milestone billing (deposit invoices)
- Faster invoicing and consistent follow-up (how to get paid faster)
- Early-payment discounts (also expensive, but sometimes cheaper than factoring)
- An overdraft, line of credit or government-backed small-business finance
- Supply chain finance offered by some large customers to their suppliers
Does factoring change your invoices?
Usually yes: the invoice will typically show an assignment notice and the factor’s bank details, so your customer pays the factor. Everything else — numbering, tax, line items — stays the same. A clear, complete invoice also makes it more likely the factor will accept it. Create yours in the invoice generator and add the factor’s assignment wording in the notes if required.