Accounts receivable factoring is the sale of your unpaid customer invoices to a financing company (called a factor) in exchange for immediate cash. You’re selling an asset you already own rather than borrowing against it, so the transaction doesn’t add debt to your balance sheet. The factor advances 80% to 95% of each invoice within a day or two, collects payment directly from your customer, and sends you the balance minus a fee that typically runs 1% to 5% per month.
How the Transaction Works
Three parties are involved: you (the seller), the factor, and your customer (the party who owes the invoice). The factor’s main question is whether your customer will pay, not whether your own business has pristine financials. That focus is what makes factoring available to newer or fast-growing businesses that might not qualify for a bank loan.
The process begins after you deliver goods or services and issue an invoice. You submit that invoice to the factor for review. The factor evaluates your customer’s payment history and financial condition, then wires you an initial advance, usually 80% to 95% of face value. The exact percentage depends on your industry, your customer’s credit profile, and the terms of your contract.
The factor holds the remaining 5% to 20% in a reserve account. Once your customer pays in full, the factor releases the reserve to you minus the factoring fee. On a $50,000 invoice with a 90% advance ($45,000) and a 3% fee ($1,500), you’d get another $3,500 when the invoice settles.
Most factoring arrangements require your customer to be notified that the invoice has been sold. Under the Uniform Commercial Code, once your customer receives proper notice of the assignment, they must pay the factor directly and can no longer discharge the debt by paying you.1Legal Information Institute. UCC 9-406 – Discharge of Account Debtor; Notification of Assignment Non-notification factoring exists, where you keep collecting and forward payments to the factor, but it’s less common and costs more.
One structural limit to know about: factors generally cap how much of your total receivables can come from any single customer, often around 20%. If one client dominates your book of business, the amount you can actually factor may be smaller than you expect.
Recourse vs. Non-Recourse: Who Eats the Loss
The most important line in any factoring contract answers a single question: who takes the loss if your customer doesn’t pay?
In recourse factoring, you remain on the hook. If the customer goes bankrupt or refuses to pay, you buy the invoice back from the factor. Most factoring contracts are recourse agreements, and that’s why the fees on recourse deals are cheaper. An unusually low quote almost always means recourse.
Non-recourse factoring shifts the credit risk to the factor. If your customer genuinely cannot pay because of financial failure, the factor absorbs the loss. This is where misunderstandings pile up: “non-recourse” rarely means the factor eats every kind of loss. It typically covers only credit risk. If your customer disputes the invoice over a quality issue, short-shipment, or nondelivery, you’re still responsible for resolving the dispute and likely repurchasing the invoice. Non-recourse also costs more, and factors often require stronger customer credit before approving it.
Spot Factoring vs. Whole-Ledger Contracts
How many invoices you commit to factor matters almost as much as the fee.
Spot factoring, sometimes called single-invoice factoring, lets you sell individual invoices as needed. You pick which invoices and when, with no obligation to submit your full portfolio and usually no long-term contract. Rates run higher per invoice because the factor can’t count on predictable volume. Spot factoring fits businesses that occasionally need a cash bridge without an ongoing commitment.
Whole-ledger factoring (also called full-turn factoring) requires you to factor all eligible invoices, typically under a contract of 12 months or longer. In exchange, you get lower discount rates, higher advances, and reduced per-transaction fees. The factor gets predictable volume and a diversified pool of customer credit risk. The catch is you’re locked in, and leaving early can be expensive.
What Factoring Actually Costs
Factoring costs break into three components. The advance rate is the percentage you get upfront (80% to 95%). The reserve is the amount held back until the invoice pays (5% to 20%). The discount fee is what the factor charges for the service, deducted from the reserve when the invoice settles.
Discount fees are usually quoted per time period: 1% for every 10 days the invoice remains unpaid, or a flat 2% to 3% for a 30-day invoice. Many factors use tiered pricing where the rate climbs as the invoice ages. A 20-day payment might cost 2%; a 60-day payment could run 5% or more.
The Annualized Number
Monthly fees look modest until you annualize them. A fee of 3% per 30 days on invoices that turn monthly works out to roughly 36% per year. Even 1.5% per month comes to about 18% annualized. That’s substantially more than most bank lines of credit. Before signing a factoring agreement, run this calculation against what a traditional loan or credit line would cost. Ten minutes of math often changes the decision.
Fees Beyond the Discount Rate
The discount fee isn’t the only cost. Common additions include:
- Setup or application fees charged when the account is established.
- Wire transfer fees of $25 to $50 each time the factor sends an advance.
- Monthly minimums requiring you to submit a minimum dollar amount of invoices; if you fall short, you pay the difference.
- Early termination fees on whole-ledger contracts, typically 2% to 5% of annual factoring volume. On $100,000 in monthly volume, a 2% early termination fee can mean $24,000 if you leave a year early.
Many factors also require a personal guarantee from the business owner, which puts your personal assets at risk if the arrangement goes wrong. This is standard, but factors don’t lead with it in a sales pitch. Ask directly.
UCC Filings and What They Mean for Your Business
When you enter a factoring agreement, the factor will almost always file a UCC-1 financing statement with your state’s Secretary of State. This public filing notifies other lenders that the factor has a legal claim on specific business assets. Under the UCC, the sale of accounts receivable falls within the same framework that governs secured transactions, which is why the filing happens even though factoring is technically a sale.2Legal Information Institute. UCC 9-109 – Scope
The filing lists your business name, the factor’s name, and a description of the collateral being claimed.3Legal Information Institute. UCC 9-502 – Contents of Financing Statement The collateral description is the part to pay attention to. A specific lien limited to accounts receivable leaves your equipment, inventory, and other assets available for other financing. A blanket lien covering “all assets” ties up everything you own and can make it very hard to get a bank loan, equipment financing, or any other credit while the filing is active.
Before signing, confirm in writing whether the UCC-1 will cover only receivables or all business assets. If you already have a lender with a blanket lien, the factor will need a subordination or intercreditor agreement with that lender before establishing priority. Filing fees themselves are modest, generally $5 to $40 depending on the state, but the lien type can shape your borrowing options for years.
Once you sell an invoice, you no longer have a legal or equitable interest in it. The UCC states this directly: a business that has sold an account retains no ownership rights in what was sold.4Legal Information Institute. UCC 9-318 – No Interest Retained in Right to Payment That Is Sold If your business later faces creditor claims or bankruptcy, sold receivables belong to the factor, not to your creditors. You also can’t use already-factored invoices as collateral for other financing or redirect the customer’s payment back to yourself.
How Factored Income Is Taxed
The IRS treats the cash you receive as business income. You report the full invoice amount as revenue, and the factor’s discount fee and other charges are deductible as ordinary business expenses. For cash-method taxpayers, income is recognized when you actually or constructively receive it.5Internal Revenue Service. Publication 538 – Accounting Periods and Methods For accrual-method taxpayers, recognition depends on when all events establishing your right to payment have occurred, which in most factoring arrangements is the invoice date.
The factor is not required to send you a 1099, because they’re buying an asset rather than paying you for services. Keep detailed records of every invoice sold, the fees charged, and the transaction dates. The record-keeping burden falls on you.
Factoring vs. a Bank Loan
The fundamental difference is that factoring is a sale and a loan is debt. Factoring converts an existing asset into cash. A loan creates a new liability. That distinction runs through every other comparison.
Credit assessment works differently. A bank evaluates your business’s financials, credit history, and often your personal credit. A factor evaluates your customers’ credit. If your business is new or thinly capitalized but sells to strong commercial customers, factoring may be available when a bank loan is not.
Balance sheet treatment differs too. Accounting rules require a transfer of receivables to meet specific isolation and control tests before it qualifies as a true sale rather than a secured borrowing.6Financial Accounting Standards Board. Accounting Standards Update 2009-16, Transfers and Servicing (Topic 860) When those tests are met, the transaction is recorded as a sale of an asset, and your debt-to-equity ratio doesn’t move. A bank loan shows up as a liability and increases leverage.
Repayment works differently. Your customer pays the factor directly, so there’s no monthly payment on your side. A loan requires scheduled principal and interest regardless of when your customers pay you. On raw cost, factoring almost always loses. You’re paying for speed, accessibility, and outsourced collections.
When Factoring Makes Sense
Factoring fits businesses that sell to creditworthy commercial customers on 30-, 60-, or 90-day payment terms and need cash sooner than those terms allow. Staffing agencies, trucking companies, manufacturers, and distributors are the heaviest users because they carry large upfront costs, such as payroll, fuel, and raw materials, while waiting weeks or months for payment. If your customers are solid but slow, factoring converts their good credit into your working capital.
Factoring is a poor fit when your margins are too thin to absorb the fees. A business running on 5% net margins can’t sustain a 3% monthly factoring cost without going backward. It’s also problematic when your customer base is highly concentrated, since debtor concentration limits may prevent you from factoring your largest invoices. And if you qualify for a traditional line of credit, the math almost always favors the cheaper option. Factoring fills a real gap in the financing market, but it works best as a stepping stone to cheaper capital rather than a permanent feature of your financial structure.