Accounts Receivable Factoring: Selling Invoices for Cash

Cash Today, Invoice Later

A staffing company invoices a corporate client $200,000 for services rendered. The client's standard payment terms are net-60. The staffing company needs payroll covered in 10 days. Accounts receivable factoring solves this mismatch: the company sells the $200,000 invoice to a factoring firm for $188,000 to $192,000 in immediate cash. The factoring company then collects the full $200,000 from the client. The business gets liquidity without a loan, without debt covenants, and without waiting 60 days. Factoring is one of the oldest financial tools in commerce, used widely in industries with slow-paying customers: staffing, trucking, manufacturing, healthcare, and government contracting.

How the Transaction Works

Factoring involves three parties: the business (seller/client), the factor (financing company), and the account debtor (the customer who owes the invoice).

• Step 1: Business delivers goods or services and issues an invoice to its customer
• Step 2: Business sells the invoice to the factoring company, typically receiving 70–90% of face value as an advance (the "advance rate")
• Step 3: Factor notifies the customer (in notification factoring) or the business collects (in non-notification/confidential factoring)
• Step 4: Customer pays the factor directly on the invoice due date
• Step 5: Factor remits the remaining balance (the "reserve") to the business, minus fees

The effective cost is the factoring fee, typically expressed as a percentage of invoice face value per week or month the invoice remains outstanding.

Recourse vs Non-Recourse Factoring

The most critical distinction in factoring contracts is who bears the risk if the customer doesn't pay.

True non-recourse factoring is less common than marketed. Many contracts exclude non-payment due to disputes, which covers the most common reasons customers don't pay — making the "non-recourse" protection narrower than it appears.

Fee Structure and True Cost

Factoring fees are typically quoted as a percentage of invoice value, often tiered based on how long the invoice takes to be paid. A sample structure:

• 1–15 days outstanding: 1.5% of invoice face value
• 16–30 days: additional 0.5% (2.0% total)
• 31–45 days: additional 0.5% (2.5% total)
• 46–60 days: additional 0.5% (3.0% total)

On a $200,000 invoice paid in 45 days, total fees are $5,000 (2.5%). Annualized, this approximates 20% APR—substantially higher than a line of credit but available to businesses that cannot qualify for bank financing. Speed costs money.

Industries That Use Factoring Most

Qualification Requirements

Factoring approval depends primarily on the creditworthiness of the business's customers, not the business itself. This makes factoring accessible to startups and businesses with poor or thin credit history.

• Invoices must be for completed work or delivered goods (no progress billing without disclosure)
• Invoices must be free of liens or prior assignments to other lenders
• Customer (account debtor) must be a creditworthy business or government entity — consumer receivables typically excluded
• Invoices must not be disputed or subject to offset claims
• Minimum monthly volume requirements vary: typically $10,000–$50,000 per month

Factoring vs. Asset-Based Lending

Asset-based lending (ABL) is a related but distinct product. ABL uses accounts receivable (and often inventory) as collateral for a revolving line of credit. Unlike factoring, the business retains ownership of the receivables and a lender relationship. ABL facilities typically carry lower costs (Prime + 2–4%) but require more rigorous reporting, field audits, and higher minimum borrowing bases. Factoring is simpler but more expensive; ABL is cheaper but has more conditions. The breakpoint for considering ABL is typically $2–5 million in annual receivables.

Risks and Drawbacks

Factoring carries operational and financial risks beyond the cost premium. Customer notification can signal financial distress to key clients. Concentration limits may restrict factoring of invoices from a single large customer. Some factors require blanket assignments of all receivables, preventing selective factoring. Contract terms—minimum volume commitments, termination penalties, and fee structures—require careful legal review before signing. In competitive industries where payment terms are a sales tool, factoring arrangements can complicate negotiations with customers who prefer to pay on their own schedule.

This article is for informational purposes only and does not constitute financial or tax advice.