Invoice factoring: Improve your small business cash flow fast
Invoice factoring helps businesses get cash fast by selling unpaid invoices to a third party. Learn how it works.

Published Friday 10 October 2025
Table of contents
Key takeaways
• Evaluate invoice factoring when you experience cash flow gaps from 30-90 day payment terms, as it provides 80-90% of invoice value within 24-48 hours without requiring debt on your balance sheet.
• Calculate the total cost carefully before proceeding, as factoring fees typically range from 1-5% of invoice value (sometimes up to 15%), making it more expensive than traditional bank loans but faster to obtain.
• Choose recourse factoring cautiously since you remain responsible for buying back any invoices the factoring company cannot collect, which requires maintaining sufficient cash reserves for potential repurchases.
• Select a factoring company based on industry expertise, transparent fee structures, and contract flexibility, as they will handle customer collections directly and potentially impact your client relationships.
What is invoice factoring?
Invoice factoring is a financing method where you sell your unpaid invoices to a third-party company for immediate cash. The factoring company then collects payment directly from your customers and keeps a fee for the service.
This gives you immediate access to cash instead of waiting 30 to 90 days for customer payments; for large corporations, this can involve significant sums, with one company reporting cash proceeds of $1,496 million from factoring in a single year. It's essentially a cash advance against your outstanding invoices.
Once you sell your invoices to the factoring company, you receive a percentage of their value right away. You do not need to approach a lender, financing company, or bank.
How does invoice factoring work?
Invoice factoring gives small businesses quick access to cash by selling unpaid invoices to a third party. Instead of waiting weeks or months for customers to pay, you receive most of the invoice value upfront, while the factoring company collects payment directly from your customer.
Common types of invoice factoring
- Spot factoring: Selling your invoices to a third party for a one-time deal.
- Recourse factoring: This is the most common type of factoring. You agree to buy back any invoices the factoring company cannot collect, though some companies utilize non-recourse agreements to avoid this risk.
- Non-recourse factoring: The factoring company assumes the risk of the customer not paying the invoice. The factoring company charges higher fees to cover the cost of the risk.
The invoice factoring process
The invoice factoring process involves several steps. Here’s how it works from start to finish:
- Complete the work: Provide goods or services to your customer and send them an invoice
- Sell the invoice: Submit the invoice to your factoring company before it's due
- Get immediate payment: Receive 80-90% of the invoice value within 24-48 hours
- Customer pays the factor: Your customer pays the factoring company directly when the invoice is due
- Receive final payment: The factoring company pays you the remaining balance minus their fee
Benefits of invoice factoring
Invoice factoring offers a straightforward way to improve your cash flow without taking on new debt. It's not a loan, so it won't appear on your balance sheet as a liability. This option helps you maintain a strong financial position while accessing funds quickly.
Invoice factoring offers several key advantages for small businesses:
- Fast funding: Get cash within 24-48 hours instead of waiting weeks for bank loan approval
- No debt on your books: This is a sale, not a loan, so it doesn't affect your credit score or require collateral
- Flexible customer terms: Offer longer payment periods to win more clients while still getting paid quickly
- No credit requirements: Approval is based on your customers' creditworthiness, not yours
Invoice factoring costs
Invoice factoring provides quick funding, but you pay fees for this service. These fees can be higher than those for a traditional bank loan. Make sure you understand the costs before you choose this option.
Fees typically include:
- Factoring fee: A percentage of the invoice's total value, usually between 1% and 5%. However, specific agreements show that fees range from 2.75% to 15% of an invoice's face value, depending on how long it takes to collect. This fee compensates the company for processing the invoice and collecting payment.
- Advance rate: This is the percentage of the invoice value you receive upfront, typically 70% to 90%. The actual rate can depend on the type of receivable; one company's agreement specified an advance of 35% of the foreign receivables versus 75% for domestic ones. The remaining amount, minus the factoring fee, is paid to you after your customer pays the invoice.
Check for any additional charges in your agreement. Ask about setup fees, service charges, or penalties for late customer payments.
Invoice factoring example
Here’s how invoice factoring works in practice.
Suppose your construction company completes a project and sends a $10,000 invoice to your client with 60-day payment terms. You need cash now to buy materials for your next job.
Here's how it could unfold:
- You sell the $10,000 invoice to a factoring company.
- The company gives you an 80% advance, so you receive $8,000 within a few days.
- The factoring company collects the full $10,000 from your client when the invoice is due.
- Once paid, the company deducts its 3% fee ($300) and sends you the remaining balance of $1,700.
In the end, you received $9,700 and got most of it almost two months early. This allowed you to keep your business running smoothly without waiting for your client to pay.
When to use invoice factoring
Invoice factoring can be a powerful tool for many businesses. It is especially useful if you have long payment cycles but need consistent cash flow to operate and grow.
Consider using invoice factoring if your business:
- Experiences cash flow gaps: If you often wait 30, 60, or 90 days for customer payments, factoring can bridge the gap.
- Is growing quickly: Rapid growth requires capital for inventory, staff, and equipment. Factoring provides the funds to support your expansion.
- Has seasonal demand: If your business is busy during certain times of the year, factoring can help you manage upfront costs before your peak season revenue comes in.
Invoice factoring vs other financing
Invoice factoring is one way to fund your business. Compare it to other options to see if it fits your needs.
Invoice factoring vs invoice discounting
Invoice discounting is similar to factoring, but with one key difference: you remain in control of collecting payments from your customers. With discounting, you use your invoices as collateral for a loan. Your customers are not aware of the arrangement. This helps you maintain your existing client relationships.
Invoice factoring vs a bank loan
A traditional bank loan provides a lump sum of cash that you repay over time with interest. Getting a loan depends heavily on your credit history and business assets. Factoring, on the other hand, is based on the creditworthiness of your customers. It's often faster and easier to qualify for than a bank loan, but the fees can be higher.
Invoice factoring pros and cons
Consider these factors before choosing invoice factoring:
High costs: Factoring fees typically range from 1% to 5% of invoice value, making it more expensive than traditional loans.
Loss of control: The factoring company handles all customer collections, which can affect your client relationships.
Recourse risk: With recourse factoring, you must buy back any invoices the company can't collect. To manage this, some agreements require the seller to maintain deposits in a restricted cash account to cover potential obligations on uncollected invoices.
Also:
- You can't use invoice factoring if your business doesn't issue invoices.
- You may not qualify for factoring if your customers have bad credit, a poor payment history, or if they rely too much on their credit card.
- Because factoring companies can pursue unpaid invoices aggressively, you risk damaging your relationships with clients. Factoring is therefore risky if you're a small business with a limited client pool.
Choosing a factoring company
Choosing the right factoring company requires evaluating several key factors. Here’s what to assess:
- Industry expertise: Does the company have experience in your specific industry and understand your business model?
- Contract flexibility: What are the terms for contract length, cancellation fees, and repayment schedules?
- Fee structure: How do they charge fees, and what's the total cost per invoice?
- Customer service quality: Do they provide responsive support when you need help?
Manage your cash flow with confidence
Invoice factoring can be a great solution for managing cash flow, but it starts with clear and professional invoicing. Xero makes it easy to create, send, and track your invoices from anywhere. With real-time insights into your finances, you can make smarter decisions about when and how to use financing options like factoring.
Take control of your business finances with Xero accounting software. Try Xero for free today.
FAQs on invoice factoring
Here are some common questions and answers on invoice factoring for small businesses.
Is invoice factoring a good idea for small businesses?
If you need faster access to funds because your customers take time to pay, factoring can help. It is often more accessible than a bank loan, especially for new or fast-growing businesses.
Why is invoice factoring more expensive than traditional loans?
Factoring companies take on the risk if your customer does not pay. They also manage the collections process for you. The fees cover this risk and service. While the cost may be higher, you pay for speed, convenience, and less administration.
Do banks offer invoice factoring services?
Some banks and financial institutions offer invoice factoring as part of a broader suite of business financing products. Many businesses work with specialized factoring companies that focus only on this type of funding. These companies may have more experience in specific industries.
What's the difference between invoice factoring and invoice discounting?
With invoice factoring, the factoring company buys your invoices and collects payment from your customers directly. With invoice discounting, you use your invoices as collateral for a loan, but you remain responsible for collecting payments. Your customers are typically unaware of the arrangement.
How quickly can I get funding through invoice factoring?
One of the biggest advantages of factoring is speed. After the initial setup, you can often receive funds within 24 to 48 hours of submitting an invoice. This makes it an effective solution for immediate cash flow needs.
Disclaimer
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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