Invoice Factoring

How factoring works

You issue an invoice to your customer for, say, \$10,000 net 30. Instead of waiting 30+ days, you sell that invoice to a factor for ~\$9,500 today. The factor collects the \$10,000 from your customer when due.

Two flavors exist: recourse factoring (you eat the loss if the customer doesn't pay — cheaper) and non-recourse (the factor takes the credit risk — more expensive). Most small-business factoring is recourse.

True cost and when it's appropriate

A 5% discount on a 30-day invoice is roughly 60% APR. That sounds catastrophic, and it is — for ongoing financing. But factoring isn't really an interest rate; it's a one-time fee for fast access to cash you've already earned. Used selectively to cover payroll while waiting on a slow enterprise customer, it can be the right call.

Used systematically — factoring every invoice — it eats margin and signals to lenders that the business can't manage working capital. A business line of credit is almost always cheaper if you can qualify.

When factoring makes sense — and when it doesn't

Factoring is rarely cheap money. Effective rates of 12-30% APR are common once you annualize the discount, and recourse factoring leaves you on the hook if the customer doesn't pay. The math only works when the alternative is worse — the customer is creditworthy but slow, your gross margin is high enough to absorb the discount, and the cash unlocks growth or avoids a covenant breach.

Non-recourse factoring shifts the credit risk to the factor and is more expensive, but for businesses with concentrated customers it can be a useful insurance policy. The factor effectively underwrites the customer and refuses to advance against names they don't like — that signal alone is valuable, even if you never use the financing.

Watch for the contract terms more than the headline rate. Many factoring agreements have minimum monthly volumes, all-asset liens, lockbox requirements, and customer notification clauses that change the way your business operates. A line of credit at a higher headline rate is often cheaper after you factor in (pun intended) the operational drag.

If you do go the factoring route, plan an exit. Most factoring relationships should be transitional — a 12-24 month bridge while you build the credit profile to qualify for a traditional bank line at much lower cost. Companies that get stuck in factoring for 5+ years usually do so because they never built the financial discipline that would let them graduate; the cost compounds enormously over time.