Factoring
Factoring is a financial transaction where a business sells its accounts receivable (unpaid invoices) to a third party — called a factor — at a discount in exchange for immediate cash. Instead of waiting 30, 60, or 90 days for customers to pay, you get most of the money upfront.
Factoring Definition
Factoring is a financial transaction where a business sells its accounts receivable (unpaid invoices) to a third party — called a factor — at a discount in exchange for immediate cash. Instead of waiting 30, 60, or 90 days for customers to pay, you get most of the money upfront.
Factoring in Practice — Example
Your construction company just finished a $50,000 project, but the client's payment terms are Net 60. You need cash now to cover payroll and buy materials for the next job. A factoring company buys the invoice for $47,500 (95% of face value) and deposits the money into your account within 24 hours. When your client pays the full $50,000 in 60 days, the factor keeps the difference as their fee.
Why Factoring Matters for Your Business
Cash flow gaps are the number one reason small businesses fail, and factoring exists specifically to close those gaps. If your business is profitable but cash-poor because customers take weeks or months to pay, factoring converts those outstanding invoices into working capital immediately.
Unlike a loan, factoring doesn't create debt on your balance sheet. You're selling an asset (the receivable), not borrowing against it. This makes factoring attractive to businesses that can't qualify for traditional financing or don't want to take on more debt.
The trade-off is cost. Factoring fees typically range from 1–5% of the invoice value, which can add up quickly. It's a useful tool for bridging cash flow gaps, but it shouldn't become a permanent crutch — if you're factoring every invoice, it may be time to renegotiate payment terms with customers.
How Factoring Works
| Step | What Happens |
|---|---|
| 1 | You deliver goods/services and invoice your customer |
| 2 | You sell the invoice to a factoring company |
| 3 | Factor advances 80–95% of invoice value (usually within 24 hours) |
| 4 | Your customer pays the factor directly on the due date |
| 5 | Factor sends you the remaining balance minus their fee |
| Factor Type | Description |
|---|---|
| Recourse | You're liable if the customer doesn't pay |
| Non-recourse | Factor absorbs the risk of non-payment (higher fees) |
Factoring vs Business Line of Credit
Factoring sells your receivables for immediate cash with no debt created. A line of credit is a revolving loan you draw from and repay with interest. Factoring approval is based on your customers' creditworthiness; credit lines are based on yours. Factoring is faster but typically more expensive per dollar.
FAQ
Q: How much does factoring cost?
A: Factoring fees typically range from 1–5% of the invoice value, depending on invoice size, customer creditworthiness, and payment terms. Longer payment terms and riskier customers mean higher fees.
Q: Will my customers know I'm factoring?
A: In most cases, yes. The factor typically collects payment directly from your customer. Some factors offer "non-notification" factoring where your business name remains on communications, but this is less common and more expensive.
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