What Is Invoice Factoring and How Does It Improve Cash Flow?

Invoice factoring is a way to get paid on an invoice today instead of waiting 30, 60, or 90 days for a client to pay it. Instead of waiting, you sell the unpaid invoice to a factoring company, who pays you most of its value upfront and collects payment from your client directly.

How it actually works

1. You deliver the work or product and issue an invoice to your client as usual.
2. You submit that invoice to a factoring company instead of just filing it and waiting.
3. The factoring company advances you a large portion of the invoice, commonly in the 80-90% range, usually within a day or two.
4. Your client pays the invoice directly to the factoring company on its normal due date.
5. Once collected, the factoring company sends you the remaining balance, minus their fee.

Recourse vs. non-recourse factoring

With recourse factoring, you're responsible for buying back the invoice if your client never pays. With non-recourse factoring, the factoring company absorbs that risk, but charges a higher fee for taking it on. Most small business factoring arrangements are recourse, since it's cheaper and most invoices do eventually get paid.

What it costs

Factoring fees vary by industry, invoice size, and how creditworthy your clients are, not how creditworthy you are, since the factoring company is really underwriting your client's ability to pay. Fees are usually structured as a percentage of the invoice per month it remains unpaid, so the faster your client pays, the less it costs you. This makes factoring meaningfully more expensive per dollar than a traditional loan, which is the tradeoff for speed and for not needing the collateral or credit history a bank loan requires.

When it makes sense

• Your business has real, collectible invoices, the problem is timing, not creditworthiness of the work itself.
• You need cash faster than a bank loan application could ever move.
• Your clients are other businesses with a track record of paying, just slowly.
• You'd rather pay a fee for speed than turn down growth because cash is tied up in receivables.

When a line of credit makes more sense instead

If your business qualifies for a business line of credit, it's usually the cheaper option for ongoing cash flow gaps, since you're borrowing against your own credit rather than selling a receivable at a discount. Factoring tends to make more sense for newer businesses that don't yet qualify for traditional financing, or for a sudden spike in slow-paying invoices that a credit line wasn't sized for.

For where this fits into a broader plan rather than a one-off fix, see our complete guide to small business cash flow management. And if the underlying issue is the profit-vs-cash-in-hand gap itself, cash flow vs. profit explains why that gap exists in the first place.