Invoice factoring, also known as accounts receivable financing, is a financial solution that allows businesses to convert 70 percent to 90 percent of unpaid invoices into immediate cash. Its main draw is that it improves cash flow, but businesses can also appreciate that it reduces the burden of collections and helps maintain the healthy working capital necessary for business growth. 

We’ll explore the ins and outs of invoice factoring to help you decide if its potential benefits make it a good fit for your business needs. 

What is invoice factoring?

Invoice factoring is a short-term alternative financing option for businesses that send invoices to customers. 

Businesses can sell their outstanding invoices to an invoice factoring company. The factoring company pays most of the invoice’s value upfront and takes on the responsibility of collecting the invoice from the client. This allows businesses to receive money from invoices earlier than they normally would, as invoices often take between 30 and 90 days to be paid. 

Companies can use the money from invoice factoring for whatever they need. Once the client pays the invoice, the invoice factoring company will take out their fees and interest and then pay the company any remaining funds they are owed. 

Invoice factoring works for businesses that might not qualify for a traditional business loan because they don’t have the typical loan requirements. Factoring doesn’t require good credit or a traditional loan application process from the business.

Is invoice factoring a loan?

While often lumped in with loan options, invoice factoring isn’t technically a loan. When you sign on to work with a factoring company, they pay you for the invoice and take on the responsibility of collecting payment from the client. 

Also unlike a loan, the factoring company will look at your clients’ creditworthiness instead of your business’s to determine if they will work with you. 

How does invoice factoring work?

The invoice factoring process involves three key parties: the business (you), the client you invoice and the invoice factoring company.

Basically, the factoring company provides immediate cash, based on a percentage of the invoice value, to the business and collects payment from the customer directly. 

Invoice factoring works in a few straightforward steps:

  1. You complete work for the client and send an invoice. 
  2. The invoice factoring company vets the client for creditworthiness. 
  3. If the invoice factoring company approves the client, they will advance you 70 percent to 90 percent of the invoice value. 
  4. The client pays the invoice factoring company directly. 
  5. The invoice factoring company takes out any fees and interest and sends you the remaining amount you are owed from the invoice. 

Here’s an example of what this might look like:

Invoice value $30,000
Initial advance (90% of invoice value) $27,000
Total interest and fees charged by invoice factoring company (4% of invoice value) $1,200
Additional payment you receive after client pays invoice ($30,000-$27,000-$1,200) $1,800
Total received $28,800

Cost of invoice factoring

You will be responsible for the fees associated with the service, which the invoice factoring company will automatically deduct from the client’s payment. Some invoice factoring companies may have hidden fees, so read the fine print before signing an agreement with an invoice factoring company.

These are fees the invoice factoring company may charge you:

  • Interest: Typically 0.5 percent to 4 percent. This may be a one-time fee or may accumulate weekly or monthly while the invoices go unpaid.
  • Late payment fee: Charged if a client pays the invoice after the due date.
  • Returned check fee: Charged if the client’s check bounces.
  • Wire transfer fee: Charged by some companies if the client pays by wire transfer.
  • Origination fee: Sometimes charged when you start a contract with a factoring company.
  • Termination fee: Sometimes charged when you end your contract with the factoring company

Invoice factoring vs. invoice financing

Invoice factoring and invoice financing are two different ways to receive the funds for an invoice before the client pays. 

Invoice factoring works via a relationship between the invoice factoring company and the client. On the other hand, invoice financing works like a traditional loan via a relationship between the lender and the business creating the invoice. Invoice financing uses the invoice like collateral for the loan. 

Here are the key differences between the two processes:

Invoice factoring Invoice financing
Lender Invoice factoring company Bank or other loan originator
Party responsible for making payments Client Business
Gets credit checked by lender Client Business
Process – Lender pays business advance
– Client pays lender for invoice
– Lender takes out fees and pays any remaining amount to business
– Business must apply to qualify and gets approved amount of funds from lender
– Client pays business for invoices
– Business pays lender monthly payments or total amount to pay off the loan
Reborrowing Business can keep submitting invoices to the lender until they end an agreement with the lender Borrowing more funds requires applying again with the lender

Invoice factoring pros and cons

Invoice factoring can be a great option if you need money for your business quickly. However, it’s not always the right option. Here are the pros and cons of invoice factoring for you to consider.


  • Quick cash: Traditional business loans can take a few weeks or months to fund. For faster cash, you could apply for a fast business loan or opt for invoice factoring, which pays you between 70 percent and 90 percent of the invoice value within a few business days. 
  • No impact on your credit score: Invoice factoring may be the right choice if you have bad credit or you just don’t want your credit score impacted. The process relies on the creditworthiness of your clients rather than your business. 
  • More predictable cash flow: Clients who lag in paying invoices can make it hard for you to pay bills on time. With invoice factoring, you can let the factoring company take care of collecting the payments and be certain of what cash you will have and when. 


  • Reduces profit margins: Instead of collecting the total amount of the invoice, you give up any interest and fees that the factoring company charges for their service. 
  • Hidden fees: Some invoice factoring companies may have hidden fees that you haven’t accounted for, resulting in even lower profit margins for you. 
  • Your clients must qualify: Qualifying for invoice factoring relies on your clients’ creditworthiness. If your clients don’t qualify by the factoring company’s standards, you won’t be able to participate in invoice factoring. 

How to choose the best invoice factoring company

It’s essential to evaluate different invoice factoring companies since they vary in size, expertise and offerings. To make an informed decision, carefully consider their strengths, limitations and specialized services that align with your business needs.

Here are a few things to consider when choosing an invoice factoring company:

  • Industry: It can be beneficial to work with an invoice factoring company familiar with your industry and its challenges.
  • Advance rate: Depending on how much capital you need, working with a company that offers a high advance rate is crucial.
  • Interest rate: Too high of interest can lower your profits, meaning you have less capital to work with. 
  • Funding time: If you need funding fast, you want to choose a company that can get you funds within the required timeframe.
  • Fees: Consider the fees the company charges and how much those fees will increase the overall cost of invoice factoring.

Invoice factoring alternatives

If you decide invoice factoring isn’t the right option for your business, there are other options to consider. Here are some funding alternatives that may be the right choice for your business:

  • Invoice financing: Invoice financing is another way to get advance funding for your business. If you have good credit, this can be another option for your business.
  • Business loan: Do you need more cash all at once? Consider applying for a business loan from a bank, credit union, online lender or the SBA. While funding can take longer and there are fees, you can use the lump sum for many different purposes.
  • Business line of credit: If you’d like consistent access to cash, consider a business line of credit. You can use as much (or as little) of your borrowing limit as you wish, and as you pay down your line, you have access to that amount again.
  • Upgrade your invoice management: You may be able to avoid invoice factoring just by upgrading your invoice management process. Invoicing software can make it easy for you to quickly track your invoices and send automated reminders before payments are due. Autopay and online payment methods can make the payment process easy for clients and encourage on-time payments.
  • Grants: Grants offer businesses funding that doesn’t need to be repaid. This is appealing to many business owners because there’s no risk of defaulting on a loan and no fees or credit checks, but it is a more competitive funding option to pursue.
  • Business credit cards: If you want to improve cash flow while building business credit, a business credit card is a good option. Depending on the card, you could earn rewards and perks on purchases. Also, if you don’t carry a balance month to month, you can avoid paying interest.
  • Merchant cash advance: A merchant cash advance is another alternative lending option where businesses receive a lump sum in exchange for a portion of their future credit card sales. Like invoice factoring, this also allows quick access to funds for various business needs.

The bottom line

If you’re looking for a fast way to maintain working capital and your company issues invoices, invoice factoring may be a good option for your small business. But, before working with an invoice factoring company, it’s important to review the pros and cons and overall cost to determine if it’s the best financing option for the type of funding your business needs.

Frequently asked questions about invoice factoring

  • All you have to do to qualify for invoice factoring is be a company that issues invoices. If you do, the invoice factoring company will look at your clients’ creditworthiness to determine that they want to work with you. 
  • You (the business) pay the factoring fee for invoice factoring. The factoring company automatically deducts the fees when they collect payment from the client. Total factoring fees may vary depending on the factoring company and the agreement you’ve made with them. 
  • No, you do not have to factor every invoice. Invoice factoring companies let you choose which invoices you factor depending on your current financial needs. 
  • Invoice factoring companies typically pay you an advance within a few business days. This advance is usually 70 percent to 90 percent of the total invoice amount. Once the client pays the invoice, the invoice factoring company will then pay you the remaining amount minus any factoring fees. This could take 30 to 90 additional days.