Invoice Factoring: How It Works and When to Use It

Published
July 24, 2025
Finance
Invoice Factoring: How It Works and When to Use It

Imagine this: Your business is growing, customers are happy, but your cash flow is stuck. Why? Because you're still waiting 30, 60, even 90 days for clients to pay their invoices. If this sounds familiar, you're not alone—and you're not out of options.

Enter invoice factoring—a financial solution that gives you access to the cash you've already earned. In this article, we’ll walk you through what invoice factoring is, how it works, who it’s for, its pros and cons, and how to decide if it’s right for your business. Let’s unlock your cash flow and take control of your income stream—without waiting around.

What Is Invoice Factoring?

Invoice factoring is a type of business financing that allows companies to sell their unpaid invoices to a factoring company in exchange for immediate cash. Instead of waiting for clients to pay, you get most of the invoice value up front—usually 70–90%.

The factoring company then takes on the task of collecting payment from your customers. Once your client pays, the factoring company sends you the remaining balance, minus their fee.

Think of it as turning your accounts receivable into working capital.

How Invoice Factoring Works (Step-by-Step)

Step 1: You Complete the Work and Issue an Invoice

You provide your product or service and invoice your client, typically with 30–90 day payment terms.

Step 2: You Sell the Invoice to a Factoring Company

You submit that invoice to a factoring company. They review the customer’s creditworthiness—not just yours.

Step 3: You Receive an Advance

The factoring company pays you an advance—often around 85% of the invoice value.

Step 4: The Factoring Company Collects Payment

Your client pays the factoring company directly, on the original due date.

Step 5: You Get the Balance Minus Fees

Once the client pays, you receive the remaining 15%, minus the factoring fee (often 1%–5%).

Types of Invoice Factoring

invoicing factoring

1. Recourse Factoring

You’re responsible if your client doesn’t pay. It’s riskier for you but comes with lower fees.

2. Non-Recourse Factoring

The factoring company takes on the risk of non-payment. It’s safer but more expensive.

3. Spot Factoring

You choose specific invoices to factor, one at a time. Great for occasional needs.

4. Contract Factoring

You factor all (or most) invoices over a longer term. Better rates but less flexibility.

Who Should Use Invoice Factoring?

Invoice factoring is best for:

  • B2B companies with net-30+ payment terms
  • Manufacturers, wholesalers, or service providers
  • Businesses with good-paying clients but slow payment cycles
  • Companies in growth mode that need fast capital

It may not be ideal if:

  • Your clients are high-risk or inconsistent payers
  • You have thin margins and can’t absorb factoring fees
  • You want to maintain full control of customer relationships

Real-Life Example: How It Works for a Logistics Company

Let’s say Erica owns a small freight business. Her clients pay 45 days after delivery, but she needs money now to pay drivers and fuel costs.

She sells a $50,000 invoice to a factoring company:

Receives an 85% advance: $42,500

Once the client pays, she gets the remaining 15%: $7,500

The factoring fee is 3%: $1,500

Net Cash Received: $49,000

Erica gets her money within 24 hours, keeps her business running, and avoids taking on debt.

Pros and Cons of Invoice Factoring

Pros

  • Fast access to cash
  • Improves cash flow without new debt
  • No impact on equity or ownership
  • Flexible approval based on your customers' creditworthiness
  • Can grow with your sales volume

Cons

  • It costs money (fees can add up)
  • Not ideal for poor-credit or unreliable clients
  • Clients will know you're factoring (potential perception issues)
  • Can affect your brand relationship with customers

Invoice Factoring vs. Invoice Financing

People often confuse these two, but they’re different:

  • Invoice Factoring: The factor takes ownership of the invoice and collects from the client.
  • Invoice Financing: You retain control and repay the loan after receiving client payment.

If you want to keep client contact private, financing might be a better fit. But for speed and simplicity, factoring wins.

Read More: Invoice Financing: What It Is, How It Works

How Much Does Invoice Factoring Cost?

Typical factoring fees range from 1% to 5% of the invoice amount, depending on:

  • Your industry
  • The size and number of invoices
  • Your client’s creditworthiness
  • Whether it’s recourse or non-recourse
  • The payment terms (shorter = cheaper)

For example: Factoring a $10,000 invoice with a 3% fee costs $300.

Choosing the Right Invoice Factoring Company

When picking a factoring provider, ask:

  • What are the advance rates and fees?
  • Is it recourse or non-recourse?
  • How long does funding take?
  • How will they treat my customers?
  • Are there monthly minimums or contracts?

Some top U.S. providers include:

  • BlueVine
  • altLINE
  • Triumph Business Capital
  • FundThrough
  • TCI Business Capital

Alternatives to Invoice Factoring

Not sure if factoring is right for you? Consider:

  1. Otto AI Smart Invoicing Tools

Use Otto AI invoicing platform to send, track, and automate invoices—helping reduce payment delays without needing external financing.

  1. Business Line of Credit

Access flexible funds when needed and only pay interest on what you use.

  1. Revenue-Based Financing

Pay back a fixed percentage of your monthly income—great for growing startups.

  1. Early Payment Incentives

Offer a small discount to clients who pay within 7–10 days.

When Does Invoice Factoring Make Sense?

Use it when:

  • You’re growing fast and need cash now
  • You want to avoid new debt
  • Your clients are reliable but slow to pay

Avoid it if:

  • You’re concerned about outsourcing collections
  • The costs eat too much into your margins
  • You want to keep customer relationships 100% in-house

Final Thoughts: Is Invoice Factoring Right for You?

Invoice factoring is a powerful tool—especially if you’re running a growing business and struggling with long payment cycles. It’s fast, flexible, and can free up the cash you’ve already earned.

But like any financial solution, it comes with trade-offs. Understanding your needs, your customers, and your tolerance for cost vs. speed is key.

Nikko

Nikko