Invoice factoring is a way for a business to turn unpaid invoices into cash before customers pay. The business sells the invoices to a factoring company (the factor), which pays a large share of their value right away and collects from the customers.
How it works in factoring
A typical cycle runs like this:
- The business delivers goods or services and invoices its customer.
- It submits the invoice and supporting documents to the factor.
- The factor verifies the invoice and checks the customer's credit.
- The factor advances a percentage of the invoice (the advance rate) and holds the rest as a reserve.
- The customer pays the factor directly.
- The factor releases the reserve, minus its fee.
Illustrative example: A business factors a $20,000 invoice at an assumed 85% advance rate and an assumed 3% fee. It receives $17,000 up front. When the customer pays in full, the factor keeps $600 and releases the remaining $2,400.
Because the factor is buying the receivable, approval depends heavily on the customer's ability to pay, not only on the seller's own credit history. This is why young or fast-growing companies sometimes qualify for factoring when a bank loan is out of reach.
Why it matters
Factoring is not a loan in the usual sense, but it is still financing with a cost. The terms that drive that cost are the advance rate, the fee structure, recourse provisions, minimum volumes and termination terms. Comparing offers means reading all of them together, not only the headline fee.