So, you’ve delivered the goods, sent out the invoice, and now you’re stuck waiting—probably for what feels like an eternity—for that sweet, sweet cash to hit your account. Meanwhile, your customer (let’s call them Walmart) is sitting on your money for 90 days, and your bills are piling up. Welcome to the small business hustle, where cash flow is king, and the customer is holding your throne hostage.
Luckily, you’ve got a card up your sleeve: Invoice factoring. It’s the secret weapon that lets you turn unpaid invoices into cash right now. No more waiting around while your customers play the “we’ll pay you next month” game.
What the Heck Is Invoice Factoring?
Invoice factoring is when you sell your unpaid invoices to a factoring company for immediate cash. They give you a big chunk of the invoice amount upfront—usually 70% to 90%—and then they take on the hassle of chasing down your customers for payment. Once your customer pays up, the factor sends you the rest of the cash, minus their fee.
Sounds simple, right? It is. But there are a few things you should know before diving in.
How Invoice Factoring Actually Works (Because It’s Not Magic)
Here’s how the whole thing goes down:
1. You sell to other businesses. No, your cousin who owes you $50 for that BBQ isn’t going to qualify. If you’re sending invoices to solid, creditworthy businesses—think Walmart, not Joe’s Hardware—you’re golden. The more reputable your customer, the better the deal you’ll get from the factor.
2. You hand over your invoice to the factoring company. They do some quick math and cut you a check for 70% to 90% of the invoice’s value. No, it’s not 100%, but hey, it’s better than waiting three months to get paid.
3. The factoring company goes to work collecting payment directly from your customer. And no, don’t waste your time fighting them on this. The whole reason factoring works is because the factor takes over collections. They’re not going to give you cash without some security. But here’s the good news: the Walmarts of the world aren’t going to be surprised or offended when they’re asked to send payments to a third party. They know their 90-day terms are killer on cash flow.
4. Once your customer pays up, the factor sends you the rest of the invoice value—minus their fee, of course.
Why Invoice Factoring Doesn’t Suck
Sure, you’re giving up a slice of your hard-earned cash, but if you play your cards right, factoring can be a lifesaver. Here’s why:
• Immediate Cash Flow: No more waiting around for customers to pay. Factoring gets you cash now, not 90 days from now when your customer finally gets around to paying.
• No Debt: This isn’t a loan, so you’re not taking on more debt. You’re simply selling an asset—your invoice—for cash. No repayment schedule, no interest, no messing with your credit score.
• Scalable: The more you sell, the more you can factor. It scales with your business, so as you grow, so does your ability to turn those invoices into cash.
• Startup Friendly: If you’re just starting out but have sold some invoices to solid, creditworthy customers, many factors will be able to work with you.
The Costs of Factoring: It’s Not Free Money
Okay, now for the part nobody likes: the fees. Factoring companies don’t work for free, so here’s what you can expect to pay:
• Factoring Fees: Typically, you’re looking at 1% to 5% of the invoice value. The more creditworthy your customer, the better your rate.
• Discount Rate: You’re only getting 70% to 90% of the invoice upfront. The rest comes after your customer pays, minus the factor’s cut.
• Hidden Fees: Some factoring companies love to sneak in extra charges for things like invoice verification, administrative costs, and other nonsense. Some of these fees are negotiable so read the fine print and think about how your customers pay in real life and project what this means to your bottom line.
Recourse vs. Non-Recourse Factoring: Choose Wisely
You’ve got two flavors of factoring: recourse and non-recourse.
• Recourse Factoring: If your customer flakes and doesn’t pay, you’re on the hook. You’ll have to buy back that unpaid invoice. The upside? It’s cheaper than non-recourse factoring.
• Non-Recourse Factoring: Here, the factor takes on all the risk. If your customer skips town, the factor eats the loss. But you’ll pay more for that peace of mind.
Use the Right Tool for the Job
Let’s be real: if your cash flow issues are truly caused by slow-paying B2B receivables, factoring your invoices is probably the smart move. But if your inventory isn’t turning or your margins stink, congratulations—you don’t have a funding problem, you have a business problem.
Now, if you do have solid invoices and you just need cash faster, don’t get lazy and go for the “easy” route of a merchant cash advance or revenue-based financing product. Sure, it’s quick, but in the long run, you’re putting yourself in a cycle of debt. Here’s why factoring wins in the end:
• More Capital as You Generate More Invoices: Factoring grows with your business. The more you invoice, the more you can factor and the more cash you have on hand.
• Stay Out of Unnecessary Debt: Factoring is not a loan. You’re not adding debt to your books, so no ugly repayment schedule.
• Save on Your Cost of Capital: Because you’re using the right tool for the job, you’re saving yourself from the high costs of stacking short-term, expensive loans.
I’ve seen way too many companies, with slow paying B2B receivables, fall into the trap of taking out a cash advance or revenue-based financing product, needing more capital as new invoices roll in, and getting caught in a tailspin of stacking high-cost loans. The biggest cause of this tailspin is because they were lazy or felt “icky” about assigning collections to the factor. This is a moronic way to run your business. Don’t be that person.
Don’t Even Bother if You’re Selling to Individuals
Factoring is for business-to-business transactions. So, if you’re hoping to factor invoices for individual customers, it’s time to rethink your strategy. No one’s going to factor your Aunt Sally’s invoice for $100. Factors want businesses with real revenue streams and creditworthy customers.
When Factoring Makes Sense (And When It Doesn’t)
Invoice factoring is a great solution if you’re stuck waiting on long payment terms (30, 60, or 90 days) and need fast access to working capital. It’s especially useful if you’ve got creditworthy customers with reliable payment histories. Businesses in industries like construction, trucking, staffing, and manufacturing are big fans of factoring.
But if your customer base is sketchy or has a habit of paying late, you might want to reconsider. Factoring companies are not going to be interested in buying invoices from customers who can’t be trusted to pay–and factors are not cheap, they would LOVE your business so if they’re skeptical, you should rethink who you are selling to as well or what repayment terms you offer.
What to Look for in a Factoring Company (Because Not All Factors Are Created Equal)
When shopping around for a factoring company, here’s what to keep in mind:
• Reputation: Don’t get burned by a shady factor. Stick with companies that are transparent about their fees and have a good track record.
• Fees: Know what you’re paying. Some companies like to pile on hidden fees, so make sure you understand the total cost of factoring.
• Flexibility: Some factoring companies will let you pick and choose which invoices to factor. Others will demand that you sell them all your invoices. Pick the company that gives you the flexibility your business needs.
The Bottom Line
Invoice factoring isn’t magic—it’s a tool. If you’re tired of waiting for customers to pay up and you’ve got solid, creditworthy clients, factoring can give your business the cash it needs to keep moving. Just know what you’re getting into, understand the costs, and don’t waste your time trying to bend the rules. Your customer isn’t going to be surprised when Walmart has to pay a third party, and no factor is going to hand you cash without security. And most importantly, use the right tool for the job. Don’t let the easy option of short-term debt steer you into a financial tailspin.