Invoice factoring works by selling your unpaid business invoices to a company called a factor, which pays you most of the invoice value upfront, collects the full amount from your customer when it comes due, and then sends you the remainder after deducting its fees. You get cash in 24 to 48 hours instead of waiting 30, 60, or 90 days, and because the transaction is a sale of an asset rather than a loan, it does not show up as debt on your balance sheet.
That is the shape of it. The details — how much you get upfront, what it costs, who absorbs the loss if your customer never pays, and how hard it is to walk away — are set by the factoring agreement, and they vary enough to matter.
What Has To Be True Before You Can Factor
Factoring is only available for invoices issued to other businesses or to government agencies. If your customers are individual consumers, this is not an option for you.
The invoices also have to be for work already finished or goods already delivered. You cannot factor an invoice for a job still in progress. Expect to hand over documentation that proves the transaction happened: purchase orders, signed delivery receipts, bills of lading, or approved timesheets.
The factor cares more about your customers’ credit than your own. Before buying any invoice, the factor evaluates each customer (the debtor) by looking at their payment history and financial stability. Many factors also set concentration limits — a common one is around 20%, meaning no single customer can account for more than a fifth of your factored receivables. That caps the factor’s exposure if one buyer collapses.
The Transaction, Start To Finish
Once the master agreement is signed, the day-to-day cycle is predictable.
You submit a batch of invoices, often called a schedule of accounts, through the factor’s portal or by email, along with the supporting documents that show the customer accepted the work. The factor then verifies each invoice directly with your customer’s accounts payable department, confirming the amount is right, the goods or services were received, and no dispute is pending. If a dispute surfaces during verification, that invoice usually gets pulled from the funding batch until it is resolved.
After verification, the factor wires or ACHs the advance to your bank account, typically within 24 to 48 hours. Same-day funding is sometimes available for an extra fee.
Collection is now the factor’s job. Your customer pays the full invoice amount to a lockbox or bank account the factor controls. Under the Uniform Commercial Code, once your customer has received a valid notice of assignment, paying you directly no longer discharges the debt — they have to pay the factor.1Legal Information Institute. UCC 9-406 – Discharge of Account Debtor; Notification of Assignment
When payment comes in, the factor deducts its fee and any other charges from the reserve it held back, then releases what remains — sometimes called the rebate — to you, along with a settlement report. If your customer has a legitimate complaint about defective goods or unfinished work, the UCC lets them raise the same defenses against the factor that they could have raised against you, which can reduce what the factor collects and, in turn, what you get from the reserve.2Legal Information Institute. UCC 9-404 – Rights Acquired by Assignee; Claims and Defenses Against Assignee
What It Costs
Two numbers drive the economics: the advance rate and the factoring fee.
The advance rate is the percentage of face value you receive upfront. It typically runs 70% to 95%, depending on your industry, your customers’ credit, and how risky the factor judges your receivables. The rest sits in a reserve until your customer pays.
The factoring fee, sometimes called the discount rate, is what the factor charges to buy the invoice. Fees commonly run 1% to 5% of the invoice value per month. Some factors use a flat fee regardless of how long collection takes; others use a tiered structure where the charge climbs the longer the invoice sits unpaid — for instance, 1% for the first 30 days and another 0.5% for every 15 days after that. Slow-paying customers get expensive fast, so how your factor calculates the fee over time matters more than the headline rate.
The factoring fee is not the whole cost. Common add-ons include:
- A one-time setup or due diligence fee at the start of the agreement.
- Credit check fees each time the factor evaluates a new customer.
- Wire or ACH fees on advances and reserve releases.
- Monthly service or administration fees for account maintenance and lockbox management.
- Monthly minimum fees if you fail to factor a required dollar volume.
- Misdirected payment fees when a customer pays you by mistake and the money has to be forwarded.
Ask for a complete fee schedule in writing before signing. The quoted factoring rate rarely reflects the real all-in cost.
Who Eats the Loss If Your Customer Doesn’t Pay
This is the single most consequential term in any factoring agreement.
With recourse factoring, you stay on the hook. If your customer does not pay within the recourse period, often 60 to 120 days, you have to buy the invoice back or replace it with another eligible one. The factor can also pull the unpaid amount out of your reserve or future advances. Fees are lower because the factor is taking less risk.
With non-recourse factoring, the factor absorbs the loss — but only in narrow circumstances. Most non-recourse agreements cover customer insolvency or bankruptcy and little else. If your customer refuses to pay because of a billing dispute or dissatisfaction with your work, you can still be charged back. Fees are higher to reflect the slice of risk the factor is actually taking.
One-Off or Ongoing
Factoring comes in two basic commitment structures.
Spot factoring lets you sell individual invoices as needed. No long-term contract, no monthly minimum, you choose which invoices and when. Per-invoice fees are higher in exchange for the flexibility.
Contract factoring requires you to factor most of your invoices, or all invoices from certain customers, over a set term. You generally get lower fees and higher advance rates. The tradeoffs are a longer commitment, early termination penalties, and sometimes monthly minimum volume requirements that trigger extra charges if you fall short. For steady, predictable cash flow needs, contract factoring usually costs less overall. For occasional bridges, spot avoids locking you in.
Whether Your Customer Finds Out
Under notification factoring — the more common setup — the factor sends your customer a formal notice of assignment telling them to pay the factor directly. Under non-notification factoring, your customer never learns a factor is involved; they keep paying you, and you forward the funds. Non-notification is usually offered only to established businesses with strong credit, and it carries higher costs.
Notification can prompt questions from customers who are used to dealing directly with you. Some buyers read third-party collections involvement as a sign of financial trouble, which can affect how they handle future orders or negotiations.
The UCC Filing on Your Business
To protect its claim on the invoices it is buying, the factor files a UCC-1 financing statement with your secretary of state. The filing is public and puts other lenders on notice that your receivables are already spoken for, which prevents you from pledging the same invoices as collateral elsewhere.
A UCC-1 is legally required for most factoring arrangements because the transaction involves a significant portion of your accounts. The UCC exempts small, isolated assignments, but normal factoring volumes clear that threshold and need a filing to perfect the factor’s interest.3Legal Information Institute. UCC 9-309 – Security Interest Perfected Upon Attachment The factor handles the filing, often passing the modest state fee through to you.
When the relationship ends, a UCC-3 termination statement should be filed to clear the lien. Confirming that actually happened is on you.
Getting Out of the Agreement
Ending a factoring relationship usually takes more than stopping new submissions. Most contract-based agreements require 30 to 90 days written notice. Leaving before the term expires typically triggers an early termination or buyout fee, calculated as a percentage of outstanding invoiced amounts, a flat fee, or both. Some factors also require you to repurchase every outstanding invoice still in the pipeline, which means you need enough cash to clear the book.
Before signing, read the termination clause for three things: automatic renewal language, the notice window, and the buyout formula. If you plan to switch factors, move to a line of credit, or bring collections back in-house, build the exit terms into your plan. After the agreement ends, verify that the UCC-3 was filed and the lien is off your record.
How the Fees Are Taxed
Factoring fees, including the discount rate, administration fees, and commissions, are generally deductible business expenses. The IRS treats them as either a direct deduction or a reduction of gross receipts.4Internal Revenue Service. Factoring of Receivables Audit Technique Guide Because factoring is a sale rather than a loan, the fees are not interest expense. How you report them can shift how your financials look, so settle the treatment with your accountant.