A factoring company is a finance business that buys a company's unpaid invoices at a discount and pays the business owner most of that money right away, instead of waiting weeks for the customer to pay.
In everyday terms, a factoring company (sometimes just called a "factor") turns invoices you have already sent into cash you can use now. You sell the receivable, the factor advances the bulk of its value, and then the factor collects the full amount from your customer when the invoice comes due. Once payment arrives, the factor sends you the remaining balance minus its fee. Because the decision is built around your customers' ability to pay rather than your own credit history, factoring is often available to newer or credit-challenged businesses that might not qualify for a traditional bank loan.
Key takeaways
- A factoring company buys a business's unpaid invoices at a discount and advances most of the cash right away.
- Approval depends largely on the creditworthiness of your customers, not just your own business credit.
- The factor typically pays an advance up front, holds a reserve, and releases the balance minus its fee once the customer pays.
- Recourse factoring makes you responsible for unpaid invoices; non-recourse factoring shifts certain unpaid invoices to the factor at a higher fee.
- Factoring is a sale of receivables, not a loan, so it provides working capital without adding traditional debt.
How a factoring company works
The process usually follows the same basic steps:
- You deliver work and invoice your customer. Factoring applies to business-to-business (B2B) invoices with standard payment terms, such as net 30 or net 60.
- You sell selected invoices to the factor. The factoring company reviews the invoices and, importantly, the creditworthiness of the customers who owe the money.
- The factor advances most of the invoice value. A typical advance covers a large share of the invoice up front, with the rest held back as a reserve.
- The customer pays the factor directly. In most arrangements the customer is notified and remits payment to the factoring company.
- You receive the reserve, minus the fee. When the invoice is paid in full, the factor releases the held-back amount after subtracting its factoring fee.
Two common structures are worth knowing. With recourse factoring, you are responsible for buying back an invoice the customer never pays. With non-recourse factoring, the factor absorbs certain unpaid invoices, usually at a higher fee.
A quick example with round numbers
Suppose you run a staffing agency and send a customer an invoice for $10,000 on net-30 terms. Rather than wait a month, you sell it to a factoring company.
| Step | Amount |
|---|---|
| Invoice face value | $10,000 |
| Advance paid to you up front (say 90%) | $9,000 |
| Reserve held back by the factor | $1,000 |
| Factoring fee (illustration only, say 3%) | $300 |
| Reserve released to you after customer pays | $700 |
| Total you receive ($9,000 + $700) | $9,700 |
In this illustration you collect $9,700 of the $10,000 invoice, and the $300 difference is what the factoring company keeps for advancing the cash and handling collection. The exact advance rate and fee vary by factor, industry, invoice size, and how reliably your customers pay. These figures are an example only, not a quote.
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Why it matters to a business owner
Factoring is really about timing. A business can be profitable on paper yet still run short on cash because payments arrive 30, 60, or 90 days after the work is done. A factoring company shortens that gap.
- Faster cash flow. You get working capital soon after invoicing instead of waiting out the full payment term.
- Easier to qualify for than a bank loan. Approval leans on your customers' payment history, so limited business credit is less of a barrier.
- Outsourced collections. The factor typically handles following up on the invoices it buys.
- Scales with sales. The more you invoice creditworthy customers, the more you can potentially factor.
The trade-off is cost: the factoring fee reduces what you ultimately collect, so factoring makes the most sense when quick access to cash is worth more than the discount. It is also different from a loan. You are selling an asset (the invoice), not borrowing against your balance sheet, so factoring does not add debt in the traditional sense.
Related terms
These terms come up alongside factoring:
- Accounts receivable: The money customers owe your business for goods or services already delivered. These receivables are what a factor buys.
- Advance rate: The percentage of an invoice the factor pays up front, before releasing the reserve.
- Recourse vs. non-recourse: Whether you or the factor bears the loss if a customer never pays.
- Merchant cash advance (MCA): A different product where a business receives a lump sum repaid from a share of future sales, typically through daily or weekly payments. Unlike factoring, an MCA is tied to overall revenue rather than specific invoices. MCA relief programs work only by lowering that daily or weekly payment amount, not by erasing the balance.
- Invoice financing: A close cousin where you borrow against invoices but keep ownership of them and continue collecting yourself.
Frequently asked questions
Is a factoring company the same as a bank?
No. A bank typically lends money and expects repayment with interest, weighing your business credit heavily. A factoring company buys your unpaid invoices instead, basing its decision largely on your customers' ability to pay. Factoring provides cash without adding traditional debt, though it comes with a fee that reduces the total you collect.
Who typically uses invoice factoring?
Factoring is common among B2B businesses that invoice other companies on net terms and face gaps between finishing work and getting paid. Staffing agencies, trucking and freight companies, manufacturers, wholesalers, and staffing-heavy service firms are frequent users, but any business with creditworthy commercial customers and outstanding invoices may qualify.
How much does a factoring company charge?
Fees vary by factor, industry, invoice size, and how reliably your customers pay, and are usually expressed as a percentage of the invoice value. The advance rate (the share paid up front) and the fee are set in your agreement. Always review the full terms so you understand exactly what you will receive after the fee and any reserve.
Will my customers know I am using a factor?
In most factoring arrangements, yes. Because the customer pays the factoring company directly, they are notified of the change in payment instructions. Some factors offer more discreet structures, but standard factoring involves the customer paying the factor rather than paying you.
How is factoring different from a merchant cash advance?
Factoring turns specific unpaid invoices into cash by selling them to a factor. A merchant cash advance instead provides a lump sum repaid from a percentage of your future sales through daily or weekly payments, tied to overall revenue rather than particular invoices. They solve cash-flow problems in different ways, and their costs and structures are not directly comparable.
