Accounts Receivable Factoring: A Guide to Factoring Invoices

Drake Grey of Bowtie Marketing has a story that is familiar to many small business owners: “I was constantly checking my mail looking for checks that would pay the immediate bills. My clients would always pay, but their delayed payments meant that I was constantly delaying my rent. I occasionally had to tell employees, ‘I’m sorry, but I have to delay your paycheck.’ That’s hard.”

Drake didn’t need a long-term loan, he needed short-term cash to even out the “feast or famine” nature of his business. Then he found his solution: invoice factoring. Says Grey: “I didn’t even realize how much stress this was causing until I had cash to operate and the stress was gone.”

Invoice financing, or “invoice factoring” has been around since Babylonian times. Otherwise known as “accounts receivable financing,” “receivables financing,” or just “factoring,” invoice factoring helps businesses match cash flow to their expenses.

What is Receivables Factoring?

Receivables factoring is a method of turning your invoices — which are customer promises to pay at a later date — into cash immediately. You get paid by the invoice factoring company, and the factoring company then gets paid by your customer.

How Factoring Invoices works

Let’s follow Claire’s story to understand how factoring invoices works:

How invoice factoring helped Claire

In this case, Claire was able to take on a new customer thanks to invoice factoring. But there are other situations where factoring invoices makes sense, too:

When to use accounts receivable factoring

When you need cash now to fund growth

There is an old saying that “it takes money to make money.”  Just like in Claire’s story, factoring invoices can give you funds for the supplies, payroll, etc. needed to grow.

When you need fast funding

Invoice factoring companies can approve new accounts in as few as 24 hours, and then funding can come as quickly as same-day.  If you have a cash crunch, factoring invoices can quickly fill the gap.

When you don’t qualify for a bank loan

Factors can fund businesses with poor credit or low bank balances that wouldn’t qualify for other types of financing.  This is because factoring is based on the quality of your customers’ credit – not only your own credit or business history.

When you want to focus on your business instead of managing your bank account

As a business owner, your time and focus is your most valuable resource.  Factoring receivables gives you cash when you need it so that rather than worrying about when clients will pay, you can focus on your real objective: growing your business.

What matters when choosing a factoring company


Do you want to be locked in with your factor? With most invoice factoring companies, you will sign a contract to use their services for a set time (usually at least a year), with big cancellation penalties. It may also include a required minimum amount of invoices that you factor. Other factors (like BlueVine) operate without contracts, giving you the flexibility to only factor what you actually need, and to change factors if you have a bad experience.


Notification (which is the norm) means that the factor contacts your customers directly as part of the process. In non-notification, your customer never knows what is happening in the background. (See the appendix for details.) If you want non-notification, make sure you ask as you shop around. Some factors do both and will give you the power to choose.

Service to you and customers

Factoring should solve your cash flow headaches. But if your factor isn’t transparent with you and pesters your customers, you will trade one headache for an even worse one. Pay close attention to the level of service you receive and look for online reviews, Better Business Bureau accreditation, etc. This is dramatically more important if you are considering signing a contract with a factor.

Convenience and speed

Some factors require lots of paperwork; others operate entirely online and can tap directly into your accounting software. Some give you an online dashboard where you can quickly view your status and factor new invoices; others require paperwork or phone calls for each submission. Make sure you know and are comfortable with how your factor will operate.


Look for a factor with transparent pricing. Many invoice factoring companies talk about low rates, but then have other fees that quickly raise their real costs. If a factor’s pricing is complex and confusing, it should be a flag. For details on how pricing typically works and common hidden fees, see the appendix for details.

How to work well with an invoice factoring company

The primary risk to factoring companies is fraud. If you want to keep your access to financing open and not deal with penalties, strengthen your relationship with your factor by keeping the following in mind.

  • Don’t factor invoices from bad customers: If you know a customer may not pay, then you will ruin your relationship with your factor – and if it is a recourse factor, you will end up paying off the invoice plus fees. No one wins.
  • Be upfront about bad news: If you factored what you thought was a good invoice and you find out that your customer will be late to pay, tell your factor. Having those tough conversations will go a long way toward demonstrating that you are trying to work with them, and they will be more likely to work with you.
  • Pay attention to notifications from your factor: A good factor will be on your side and will warn you when it looks like a payment may be late, or when a bank issue is preventing them from getting funds to you. Paying attention to these will save you confusion and prevent last-minute issues.

In Summary

Invoice factoring is the optimal solution for business looking for a fast and easy solution to short-term cash crunches and funding for growth. To find the best factoring company, make sure you understand your business’ needs and ask the right questions of the factors you talk to, and be careful of getting locked into contracts and hidden fees.

Appendix: the details

Jargon: understanding factoring vocabulary can help make sense of the options.


What it isWhat it means for you
Full recourseIf your customer doesn’t pay, the factor can come back to you and ask you repay the advanceOnly factor invoices from customers you know will pay.  This will keep a good relationship with your factor and prevent a bad surprise for everyone involved
Reserve accountSome factors skim a little off each invoice to build a “reserve account” that is insurance for them: if one of your customers doesn’t pay, they charge it to your reserve account. If you leave your factor, then they give you this cash back.If your factor uses a $10,000 reserve account, that is $10,000 of your cash that is useless to you until you terminate your relationship with your factor.
Reserve amountOften confused with “reserve account,” this is simply the % of the invoice held back until your customer pays — usually 10-15%Generally, lower is better: this gives you more cash to use upfront
RebateThe amount paid to you when your customer pays the invoice; this is the 10-15% reserve amount minus feesIncentives are aligned: you and the factor both want your customer to pay
VerificationA “spot check” way for the factor to prevent fraud: behind the scenes, the factoring company will verify that an invoice is real and the customer has the right payment addressVery little impact – the customer is “blind” to fact that a factor is involved
NotificationThe factor legally notifies the customer that payments should be made to the factorYour customer now knows about your factoring relationship.  Even after this, a good factor will contact your customers only after letting you know.


Additional benefits to invoice financing

  • Save time and hassle: A bank’s process requires lots of paperwork and time for small business loan, but most factoring companies can get you a decision and money within several days, and with less paperwork.
  • Speed: Factors can put the cash in your bank within 24 hours – and some can do this same-day via a wire transfer.
  • Poor or no credit is OK: Businesses with poor credit can get funding even when they don’t qualify for other types of financing, since factoring is based on the quality of your customers’ credit —  not only your own credit or business history.
  • Your bank balance doesn’t matter: Small businesses can get funding since factoring provides a line of credit based on sales, not your company’s current cash.
  • Flexible financing amount: The amount available through factoring is only limited by the amount of invoices a business has.  The business’ credit line can increase naturally as the business grows and builds its relationship with the factor.
  • No debt: Factoring is an advance on payment that is already coming to you, not a loan, so it does not appear as debt.
  • Increase your credit score: if your factor reports to a credit agency, factoring invoices will boost your credit score while simultaneously removing the stress of closely managing cash flow.

Compare to other financing options

Still unsure of the best financing for your business?  Use our interactive tool to determine the best financing for your business.

Cost: understanding the details

Factoring costs usually depend on two factors:

  • The rate
  • The time between the advance and when your client pays their invoice

For simple numbers, if the rate is 1% per week and your client will pay four weeks later, then factoring will cost you 4% of the invoice face value.

Remember that in factoring, a business typically gets 85-90% of the invoice upfront, and the rest (less fees) after the customer pays.  Bringing this all together, let’s use a business that has a $10,000 invoice and gets a 90% advance, a 1%/week fee, and a 4 week invoice.

  1. The business will get $9,000 when they factor the invoice.
  2. 4 weeks later when their customer pays, they will get $600 more – the remaining $1000 minus the $400 fee.

However, many factoring companies have other fees.  These fees can quickly increase your cost.  What may matter more, though, is whether the factor is transparent and tells you about these fees on day 1 or only reveals them late in the game.  For more on what to watch for and what to avoid, read our note on why traditional factors love your confusion.

The opportunity costs

Short-term financing is more expensive than long-term bank financing, and many businesses make the mistake of looking at financing as an expense instead of an investment – in growth, in employee morale by meeting payroll, etc. Here’s an example:

Your company has an opportunity to make $10,000 on a job, but it will cost you $8,500 in supplies and payroll upfront to do the job. You don’t have this cash, so you have to pass on the job – unless you factor an existing $8,500 invoice for 4 weeks at 1%/week.

Finance receivablesPass on the job
Potential earnings$1,500$0
Subtract the cost of factoring1% x $8500 x 4 weeks = -$340$0
Net earnings$1,160$0

In this case, saying 1% per week is “too expensive” means you lose the opportunity to grow your business by $1,160 even after the cost of factoring.

What kinds of businesses factor?

In short: all kinds, from new businesses to the Fortune 500.

Some industries that are particularly heavy users of factoring include:

  • Freelancers (marketing, PR & creative)
  • Staffing companies
  • Distributors
  • Small manufacturers
  • IT services and software development
  • Shipping and transportation
  • Construction and contractors

Any company that fits in one of these scenarios or values any of these additional benefits is a good fit, though.

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