How does invoice factoring work step by step?
Step 1: You deliver goods/services and issue an invoice to your B2B customer (net-30, net-60, etc.). Step 2: You sell that invoice to a factoring company, which advances 70–95% of face value — typically within 24–48 hours. Step 3: The factor takes over collection. Your customer pays the factor directly. Step 4: When the customer pays, the factor sends you the remaining reserve (the held-back %) minus the factoring fee (1–5% of invoice). Your gain: immediate cash instead of waiting weeks for customer payment.
What types of businesses use invoice factoring?
Factoring is most common in: staffing and temp agencies (large payroll, slow government/enterprise payments), trucking and freight (long payment terms, high fuel costs), manufacturing and distributors, government contractors, and B2B service companies. Common thread: businesses that invoice other businesses (not consumers) and have customers who pay slowly. Factoring is not used for retail or consumer sales — it requires invoiced B2B receivables.
What is the advance rate and how is it determined?
The advance rate is the percentage of invoice face value the factor pays you immediately. Typical range: 70–95%. Factors set the advance rate based on: customer creditworthiness (higher-rated customers = higher advance), invoice age and payment terms, industry (government contracts often get 90%+ due to low default risk), and your history with the factor. The remaining percentage (the 'reserve') is held until your customer pays, then remitted to you minus fees.
How do I calculate the true cost of factoring?
True cost = (Factoring fee ÷ Advance amount) × (365 ÷ Days to payment) × 100 = Effective APR. Example: $20,000 invoice, 2% fee ($400), 85% advance ($17,000), 45-day term. APR = ($400 ÷ $17,000) × (365 ÷ 45) × 100 = 19.1%. This lets you compare factoring to a LOC: $17,000 at 12% APR for 45 days costs $17,000 × 12% × (45/365) = $252. Factoring cost is $400 — 58% more than the LOC. But if you don't qualify for a LOC, factoring at 19% beats waiting 45 days with no cash.
What happens if my customer doesn't pay?
With recourse factoring: you must repurchase the invoice from the factor. This is the most common structure. Read the contract carefully — there's usually a time limit before the factor can demand repurchase (often 90 days). With non-recourse factoring: the factor absorbs the loss if your customer becomes insolvent. However, 'non-recourse' usually only covers bankruptcy — if your customer just disputes or delays payment, you may still bear responsibility. True non-recourse is narrower than the name suggests.
How is factoring different from a business line of credit?
Key differences: Factoring is off-balance-sheet (not a loan). Approval is based on your customers' creditworthiness, not yours — useful for startups or businesses with weak credit. Speed is faster: 24–48 hours vs days-to-weeks for a LOC. Cost is higher: typically 20–60% annualized APR vs 10–25% for a LOC. The factor collects from your customers — which changes the customer relationship. LOC is cheaper and preserves customer relationships, but requires good business credit and usually 1–2+ years in business.