Accounts Receivable Factoring: 101 Guide
Factoring receivables helps businesses get funding by selling unpaid invoices to a factoring company — in exchange, the business receives a cash advance on a portion of the invoiced amount. But while you’ll get cash quickly, this type of funding can be expensive, since a factoring company takes a big bite.
- Accounts receivable factoring isn’t debt — rather, it’s the sale of an asset (your unpaid invoices), so it doesn’t impact your credit score directly.
- Accounts receivable factoring may be easier to qualify for and offers quick cash, but it can also be more costly than a business loan or line of credit.
- Make sure you understand the full cost of accounts receivable factoring, including upfront and ongoing fees, before entering into an agreement with a factoring company.
What is accounts receivable factoring?
Accounts receivable factoring (also known as invoice discounting or factoring) is a way to get cash from your unpaid invoices before payment is due from customers or clients. Your business sells the invoice to a factoring company for less than its face value and receives cash payment. The factoring company handles collecting payment from the debtor.
Unlike a line of credit, accounts receivable factoring doesn’t require your business to take on debt, so it won’t impact your credit score directly. The money you receive from the factoring company isn’t a loan, since the company received an asset (the unpaid invoice) in exchange for the cash. It’s also easier to qualify and often provides faster funding.
However, the factoring company charges a factoring fee, which may be higher than the interest charges on a business line of credit. In addition, while some lines of credit are secured by accounts receivable, many are unsecured and don’t require your business to have outstanding invoices.
How factoring receivables works
Though every factoring company is different, you’ll typically follow these steps to get cash for your accounts receivable:
- Choose invoices to sell: You may choose to sell specific invoices or all accounts receivable.
- Find a factoring company: Choose a factoring company based on advance rates, fees, funding time, additional services or perks and other factors relevant to your business.
- Apply for factoring: Complete an application with the company, disclosing information about your outstanding invoices and your clients. You may set up a single transaction, known as a spot deal, or establish an ongoing arrangement with the company so you can quickly sell future invoices as needed.
- Receive payment: The factoring company disburses up to 90% or more of the face value of your accounts receivable in cash.
- Wait for the debtor to pay the factoring company: If you have a “notification” factoring agreement, either your business or the factoring company will notify your client and arrange for them to pay the factoring company by the invoice due date. If the client doesn’t pay, your business may be liable for payment, unless your arrangement with the factoring company is nonrecourse (which we’ll define later).
- Receive the remaining funds less factoring fees: Once the invoice is paid, the factoring company will issue the remaining value of the invoice in cash, keeping a cut based on the factoring fee in your agreement.
How much does accounts receivable factoring cost?
Factoring companies typically charge a factor rate (also called a discount rate), typically between 1% and 5% of the total invoice value. This fee is calculated each month the invoice remains outstanding and is subtracted from the reserve funds issued to your business once the invoice is paid.
Some factoring companies also charge additional fees, such as:
- Application or origination fee
- Credit check fee
- ACH fees
- Late payment fee
- Contract termination fee
Example: How the costs break down
Say you’re a small business owner with $100,000 in outstanding invoices due in the next 30 days, but you need that cash now to cover some of your operational expenses.
To get access to that money sooner, you work with a factoring company. You’ll sell the invoices to your factoring company, which offers an 80% advance rate with a 3% factoring fee. Within a day or so, they’ll send you $80,000 to use in your business.
| Invoice amount | $100,000 due in the next 30 days |
| Advance rate | 80% (the business will receive an $80,000 cash advance) |
| Factoring fee | 3% of invoice value charged monthly |
| Total cost of factoring |
|
Once your customers pay the invoices to the factoring company, the factoring company will release the remaining reserve to you, minus their factoring fee. If it takes the full 30 days for your customers to pay and you’re charged a 3% monthly factoring fee, you’ll get back $20,000 minus the $3,000 factoring fee, or $17,000.
Pros and cons of accounts receivable factoring
Pros
- Good for business owners with poor credit: Most factoring companies will be more concerned with your clients’ payment history than your personal credit.
- Fast funding: Many factoring companies allow you to apply online. If approved, you could receive funding within a few days, or as little as 24 hours.
- Open to startups and young companies: Time in business isn’t as important, so long as you have a track record of invoices.
Cons
- Can be expensive: Depending on the structure and fees, factoring receivables can add up quickly if your clients pay their invoices late (or not at all).
- It might damage your reputation: If your clients are notified of a factoring arrangement, it might make them wonder if your business is financially struggling.
- It could be a temporary fix: If your cash flow needs stem from low revenue or significant operating expenses, continuous invoice factoring might not be sustainable.
Types of factoring receivables
Here’s a look at the different types of factoring receivables and how they work.
Recourse vs. nonrecourse factoring
With recourse factoring, you’ll be held responsible if your clients fail to pay the factoring company. This type of factoring often requires a personal guarantee, but may come with lower fees and higher cash advances. The factoring company takes on more risk with nonrecourse factoring, so rates tend to be higher — and advance rates may be lower.
Spot vs. regular factoring
Regular factoring usually involves selling a batch of unpaid invoices all at once. Spot factoring is when a business sells a single outstanding invoice — it’s a one-off transaction that’s usually reserved for a sizable invoice. This approach might be more expensive than regular factoring.
Notification vs. non-notification factoring
With traditional invoice factoring (also known as notification factoring), the business’s clients are made aware that their invoice has been sold to an accounts receivable factoring company. Non-notification factoring is confidential — clients continue making payments to the business just as before, but the factoring company is actually the one handling the transactions.
How to choose an accounts receivable factoring company
If accounts receivable factoring sounds like the right solution for your business, take the time to find a reputable and affordable factoring company by following these steps:
- Consider companies that have expertise in your industry: Ask if the factoring company has expertise in your industry — a company’s experience working with businesses like yours may provide a smoother funding process.
- Check customer reviews and complaints for each company: Look at customer reviews and complaints on third-party websites like Trustpilot and the Better Business Bureau.
- Choose the type of invoice factoring that’s best for your business: An ongoing recourse arrangement that requires notification is less risky to the factoring company than a spot deal that is nonrecourse and non-notification. It’s therefore likely to be less costly, but you’ll need to weigh the cost against the financial risks to your business.
- Compare advance rates: Consider how much money you need to keep your business operational. Most factoring companies offer an advance of 75% to 90% of the face value of your accounts receivable, and some offer an even higher advance rate.
- Compare upfront fees and discount rates: Ask about upfront fees and factoring rates. Make sure you understand how much the advance will cost in the best- and worst-case scenarios.
- Compare additional services or perks: Some factoring companies offer services like collections handling and back-office support. Others offer industry-specific perks, like a fuel discount program for trucking companies.
- Ask about UCC filing: Some factoring companies put a UCC filing on your business when you apply for accounts receivable factoring, which gives the company priority over other creditors with regards to your receivables. UCC filings are public record, and there may be associated fees. Ask how and when the filing will be released so you understand how it will impact future borrowing.
- Check the funding time: Some factoring companies can set up your accounts receivable factoring quickly and issue the cash funds the same day, while others may take longer.
- Read the fine print before signing: Make sure to check for hidden fees or terms that could be problematic for your business before you enter into a relationship with the factoring company.
7 accounts receivable factoring companies to consider
These 7 lenders offer advance rates of 90% or higher and quick funding speeds. For more information on standout lenders and how we choose our best picks, check out our list of the best factoring companies.
| Lender | Funding limits | Advance rate | Factor rate | Funding speed |
|---|---|---|---|---|
 | Up to $5,000,000 | Up to 90% | 0.75% to 3.50% | 24-48 hours |
 | Unlimited | 100% | 2.75% to 8.25% | Within a few days |
 | Up to $2,000,000 | 95% | 2.00% to 4.00% | 24 hours |
 | Undisclosed | 97% | Undisclosed | Within 24 hours |
 | Up to $30,000,000 | Undisclosed | Undisclosed | Same day |
 | Up to $20,000,000 | Up to 95% | 0.55% to 2.00% | 24 hours |
 | Up to | Up to 90% | Undisclosed | 24 hours |
How to qualify for factoring receivables
Every accounts receivable factoring company is different, but here’s a look at common eligibility requirements:
- Accounts receivable history: Your business will probably need to demonstrate well-established invoicing practices and have a steady stream of completed invoices. This means that you’ll likely need to be in business for a little bit, though a startup business might be able to qualify if you have enough invoicing history.
- Creditworthiness: Your clients’ creditworthiness will likely be more important than your own personal credit or business credit. Most factoring companies want to see a positive payment history from your clients to feel confident that they’ll continue paying their outstanding invoices.
- Strong profit margins: Factoring companies want reassurance that your business is capable of keeping up with client demand.
- Commercial or government clients: Consumer-facing businesses typically don’t qualify for accounts receivable factoring.
Factoring companies may require you to provide the following documents:
- Personal identification
- Your application from the factoring company
- Copy of your business’s articles of incorporation and tax ID number
- The invoices you want to factor
- Your accounts receivable history and current status
Accounts receivable factoring vs. accounts receivable financing
Although factoring receivables sounds similar to accounts receivable financing, the two aren’t the same thing.
Both funding options leverage outstanding invoices, but in different ways. With accounts receivable financing, you’re using unpaid invoices as collateral to secure a loan or line of credit. In other words, accounts receivable financing uses unpaid invoices to secure another source of funding. By contrast, with factoring receivables or accounts receivable factoring, you’re getting a cash advance on your unpaid invoices.
Accounts receivable financing typically requires strong credit, which can be a stumbling block for some business owners, and it may come with a lower funding limit. However, it’s usually less expensive than invoice factoring and may provide more flexible repayment terms.
Alternatives to accounts receivable factoring
Accounts receivable factoring isn’t the best funding option for every business. If you have a business-to-consumer business, need a loan larger than the face value of your accounts receivable or have good credit and want a lower-cost option, consider these alternatives:
- Business line of credit: A business line of credit allows your business to borrow repeatedly up to a limit and repay with interest as you go. However, qualifying can be a challenge, especially for young businesses seeking an unsecured line of credit.
- Business loan: Unlike a line of credit, a small business loan provides a lump sum of cash and typically features fixed monthly payments. If you can’t get a business loan from a bank, consider an SBA-backed business loan.
- Business credit cards: Business credit cards often pay rewards for spending, and some issuers offer a 0% APR introductory period. However, credit cards have high APRs outside of these promotional periods and are best for short-term borrowing needs.
- Accounts receivable financing: Accounts receivable financing may be a business loan or line of credit secured by your accounts receivable. This type of funding may cost less than factoring, but you may not be able to borrow as much.
- Revenue-based financing: Revenue-based financing companies buy your future sales in exchange for a lump sum of cash today, also known as a merchant cash advance. You repay the money as a percentage of your revenue plus a fixed fee, allowing you flexibility if your business is seasonal or has fluctuating sales.
- Personal loans: New business owners may consider applying for a personal loan, which is typically an unsecured cash loan with fixed monthly payments. Bear in mind that not all lenders allow you to use a personal loan for business purposes, and you’ll be personally liable for repayment if your business goes bust.
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