A factor payment is money a business receives when it sells its unpaid invoices to a third party at a discount
When a company sells goods or services on credit, it creates an invoice — a promise that the customer will pay later. If the company needs cash before that payment arrives, it can sell the invoice to a factor, a company that buys receivables. The factor pays the business immediately, usually 70 to 90 percent of the invoice amount, and then collects the full payment from the customer when it's due. The difference between what the factor paid and what it collects is the factor's fee for taking on the collection risk.
Factor payments are not loans. The business is not borrowing money and repaying it — it is selling an asset (the right to collect payment) for less than its face value. This matters because factor payments do not create debt on the company's balance sheet the way a loan does, though the cost can be steep.
Key Takeaways
- A factor payment happens when a business sells its unpaid invoices to a third party and receives immediate cash at a discount.
- The factor then collects the full invoice amount from the customer, keeping the difference as its fee.
- Factor payments are used by businesses that need cash faster than their customers pay, such as staffing agencies, manufacturers, and importers.
- The cost of factoring ranges widely depending on invoice size, customer creditworthiness, and how long payment is expected to take.
- Factoring is not a loan and does not create debt, but it does reduce the amount of money the business ultimately receives from each sale.
Who uses factor payments and why
Businesses that operate on net-30, net-60, or net-90 payment terms often use factoring. A staffing agency might place workers at a client site, invoice the client for $50,000, and not receive payment for 60 days. If the agency needs to pay its workers weekly, it faces a cash flow gap. Selling that invoice to a factor closes the gap immediately.
Manufacturers, importers, and distributors use factoring for the same reason: their customers are large companies or government agencies that pay slowly, but the business has immediate expenses — payroll, materials, shipping. A small importer might receive a purchase order from a big retailer, buy inventory to fill it, and not get paid for three months. Factoring lets them fund that inventory without waiting.
Some businesses use factoring as their primary source of working capital. Others use it occasionally when a large order strains their cash reserves. The decision usually comes down to whether the cost of factoring is lower than the cost of a business line of credit or whether the business cannot access credit at all.
How the factor payment process works
The business submits invoices to the factor for review. The factor checks the creditworthiness of the customer who owes the invoice — not the business selling it. A factor will pay more readily for an invoice owed by a Fortune 500 company than by a small startup, because the risk of non-payment is lower.
If the factor approves, it advances money to the business, typically within 24 to 48 hours. The advance is usually 70 to 90 percent of the invoice face value. The business receives the cash and can use it immediately for payroll, inventory, or other expenses.
The customer pays the factor directly when the invoice is due. The factor then sends the remaining balance to the business, minus its fee. If an invoice was for $10,000 and the factor advanced $8,000 (80 percent), and the factor's fee is $800, the business receives $1,200 when the customer pays — the remaining 20 percent minus the fee.
The cost of factoring compared to other financing
Factoring fees are quoted as a percentage of the invoice face value, not as an annual interest rate. A typical fee ranges from 1 to 5 percent per 30 days, depending on the factor, the invoice size, and the customer's creditworthiness. On a $10,000 invoice with a 3 percent fee, the business receives $9,700 after the factor takes its cut.
The cost varies widely. Large invoices from creditworthy customers cost less to factor — sometimes 1 to 2 percent. Small invoices or invoices from risky customers can cost 4 to 5 percent or higher. If the customer takes 90 days to pay instead of 30, the fee may be charged three times, compounding the cost.
A business line of credit typically costs less than factoring if the business can obtain one. A line of credit might charge 6 to 12 percent annually, which works out to 0.5 to 1 percent per month. But a line of credit requires the business to may have access to based on its own creditworthiness, revenue history, and collateral. Factoring only requires that the customer — the one who owes the invoice — be creditworthy. A new business with no track record can often factor invoices when it cannot get a line of credit.
Recourse and non-recourse factoring
Recourse factoring means the business is responsible if the customer does not pay. If the customer goes bankrupt or disputes the invoice, the factor can demand repayment from the business. The business bears the collection risk, which is why recourse factoring is cheaper — the factor's risk is lower.
Non-recourse factoring means the factor bears the risk if the customer does not pay. If the customer fails to pay, the factor absorbs the loss. Non-recourse factoring costs more because the factor is taking on more risk. It typically costs 2 to 5 percent per 30 days, compared to 1 to 3 percent for recourse factoring.
Most small businesses use recourse factoring because it is cheaper. Non-recourse factoring is more common when the business is factoring invoices from customers in unstable industries or countries with high default risk.
When factoring makes sense and when it does not
Factoring makes sense when the cost is lower than the alternative. If a business can borrow at 8 percent annually but factoring costs 3 percent per month (36 percent annually), factoring is expensive. But if the business cannot borrow at all, or if waiting for payment would force it to miss payroll or turn down orders, factoring may be the only option.
Factoring also makes sense for businesses with long payment cycles and high volume. A staffing agency that invoices $500,000 per month and waits 60 days for payment has $1 million in outstanding invoices at any time. Factoring $500,000 of that at 2 percent per month costs $10,000 but frees up cash to meet payroll and grow the business.
Factoring does not make sense if the business has customers who pay quickly or if it has access to cheaper financing. It also does not make sense for businesses with very small invoices, because the factor's fixed costs make the percentage fee prohibitively high.
Factoring versus invoice financing
Invoice financing (also called invoice discounting) is similar to factoring but different in one key way: the business retains responsibility for collecting payment from the customer. The lender advances money against the invoice, but the business still sends invoices to the customer and handles collections. If the customer does not pay, the business must repay the lender.
Factoring transfers the entire collection responsibility to the factor. The factor sends invoices, follows up on late payments, and handles disputes. The business is out of the collection process entirely.
Invoice financing is cheaper because the lender's work is lighter — it does not have to manage collections. But it requires the business to have the staff and systems to handle collections itself. Factoring is more expensive but removes that burden entirely.
Frequently Asked Questions
Does factoring hurt my relationship with customers?
Not necessarily. With recourse factoring, the customer may not know a factor is involved — they still receive invoices from your company and may send payment to you or to a lockbox you control. With non-recourse factoring, the factor often handles invoicing and collections directly, so the customer knows a third party is involved. Some customers object to this; others do not care as long as they receive clear invoices and payment terms.
What happens if a customer disputes an invoice I factored?
With recourse factoring, you are responsible for resolving the dispute and repaying the factor if the dispute is valid. With non-recourse factoring, the factor handles the dispute, but if the dispute is upheld, the factor can still demand repayment from you. Always read the factor's contract about dispute handling before signing.
Can I factor invoices from any customer?
No. The factor approves based on the customer's creditworthiness, not yours. A factor will readily buy invoices from large, stable companies but may decline invoices from startups, individuals, or customers in high-risk industries. Some factors specialize in riskier customers but charge higher fees.
How quickly do I receive the money?
Most factors advance money within 24 to 48 hours of approving the invoice. Some offer same-day advances for an additional fee. The speed depends on how quickly you submit the invoice and how quickly the factor can verify the customer's creditworthiness.
Is factoring the same as a loan?
No. A loan is debt — you borrow money and repay it with interest. Factoring is the sale of an asset — you sell an invoice for less than its face value. This distinction matters for accounting and for your balance sheet, but the practical effect is similar: you receive cash now instead of waiting for payment later, and you pay a fee for that service.