What Is Factor Financing
Factor financing is a form of asset-based lending where a business sells its outstanding invoices to a third party, called a factor, at a discount. The business receives immediate cash — typically 80% to 90% of the invoice value — and the factor collects payment from the customer. Once the invoice is paid, the factor remits the remaining balance minus a fee. This process is also called invoice factoring or accounts receivable factoring, and it is one of the oldest forms of business financing, dating back centuries to the textile and overseas trade industries.
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Unlike a loan, factoring does not create debt on the balance sheet. The business is simply selling an asset — the right to collect on an invoice. This distinction matters for companies that want to improve cash flow without taking on additional leverage.
How Factor Financing Works
The factor financing process follows a straightforward sequence. First, the business provides goods or services and issues an invoice to the customer with net payment terms, often 30, 60, or 90 days. The business then sells that invoice to a factoring company. The factor advances a percentage of the invoice value, usually within one to three business days. The factor takes over collection, contacting the customer directly to arrange payment. When the customer pays the invoice, the factor releases the remaining balance to the business, minus the factoring fee.
Key Steps
- Invoice issued with clear payment terms
- Business submits invoice to the factor for purchase
- Factor advances 80% to 90% of the invoice value
- Factor manages collections from the customer
- Remaining balance minus fees is remitted to the business
Types of Factor Financing
Businesses can choose among several factoring arrangements depending on their risk tolerance and cash flow needs. The two broad categories are recourse and non-recourse factoring, and within those, there are options for whole turnover or single invoice factoring.
Recourse Factoring
In recourse factoring, the business retains the risk if the customer fails to pay. The factor can demand repayment of the advanced amount. This is the more common and less expensive form of factoring.
Non-Recourse Factoring
Non-recourse factoring transfers the credit risk to the factor, typically covering non-payment due to the customer's insolvency. However, non-recourse agreements often exclude non-payment due to disputes over the goods or services, so the business should read the contract carefully.
Selective Versus Whole Turnover
Selective factoring lets a business choose which invoices to sell, useful when only a few large invoices need immediate cash. Whole turnover factoring applies to all invoices, providing a steady cash flow stream but requiring a longer commitment.
Costs and Fees
Factor financing is priced through a discount rate, often expressed as a percentage of the invoice value. Rates typically range from 1% to 5% per 30-day period, depending on the customer's creditworthiness, invoice volume, and the business's history. Additional fees may include application fees, processing charges, or early termination fees. Because factoring is a service transaction rather than a loan, the effective annual cost can appear higher than a traditional term loan, but it reflects the speed and convenience of immediate cash.
| Fee Component | Typical Range | Notes |
|---|---|---|
| Discount rate | 1% to 5% per 30 days | Varies with customer credit and volume |
| Advance rate | 80% to 90% | Higher for creditworthy customers |
| Processing fee | Flat or per-invoice | Varies by factor |
| Termination fee | Varies | Applies if contract is closed early |
When Factor Financing Makes Sense
Factor financing is well suited for businesses with slow-paying customers, seasonal cash flow gaps, or rapid growth that strains working capital. Industries such as staffing, manufacturing, transportation, and government contracting use factoring regularly. It also benefits startups and small businesses that lack an established credit history or collateral for a traditional loan. However, factoring may not be cost-effective for businesses with highly creditworthy customers who pay on time, since the fees represent an unnecessary expense in that scenario.
Factor Financing Versus Other Options
Compared to a business line of credit, factoring is faster to set up and does not depend on the business's own credit score alone — the factor evaluates the customer's credit. Compared to asset-based lending, factoring involves selling the receivable rather than borrowing against it. For businesses weighing alternatives, the choice depends on urgency, cost tolerance, and whether the company prefers to retain collection responsibility.