Invoice Factoring: What Is It and How Can It Help Your Business?

Slow-paying customers can stretch your cash flow paper thin. Invoice factoring might be a practical solution if you're watching the days tick by while waiting for 30-, 60-, or even 90-day payment terms. It lets you fast forward through those lengthy payment wait times by turning unpaid invoices into immediate capital.

It's become a popular choice for small and medium-sized businesses that need working capital to grow, hire new staff, or manage day-to-day expenses. Small business invoice factoring also comes with an unexpected perk: it can simplify operations by outsourcing time-consuming accounts receivable tasks.

What Is Invoice Factoring?

Invoice factoring is a type of business financing where you sell your unpaid invoices to receive funds. Instead of waiting for customers to pay, a factoring company buys your invoices and pays you upfront. The factoring company is then responsible for collecting payments from your customers while you get back to running your business.

Invoice Factoring vs. Invoice Financing

Invoice factoring is a type of business funding similar to invoice financing for small businesses. However, one difference sets invoice financing and factoring apart: how payment collection is handled.

With factoring invoicing, you don't play any part in receiving payments from your customers — they pay the factoring company directly. Invoice financing uses your invoices as collateral for a loan. This means your business continues to manage accounts receivable, and you make payments to the lender.

Types of Invoice Factoring

Different types of business factoring can help in various situations. Each can come with varying fees and commitment requirements. Whether you use cash or accrual accounting, here are five of the most common receivables factoring options to consider for your business:

• Recourse factoring: You agreed to buy back any unpaid invoices from the factoring company. It's the most common option and usually has the lowest fees.
• Nonrecourse factoring: The factoring company agrees to absorb the loss if one of your customers doesn't pay. You'll typically pay higher fees because you're placing more risk on the factoring company.
• Spot factoring: You have the flexibility to sell one or many invoices at a time.
• Contract factoring: You agree to factor a minimum number of invoices each month.
• Advance factoring: You receive a large payment upfront when selling your invoices, and the rest is paid once your customer pays the factoring company.

How Does Factoring Work?

Invoice factoring is pretty simple, though it works differently than your typical small business loan. Suppose you have some unpaid invoices sitting in your books. Here's what happens next:

• Pick the invoices you want to factor: You might start with your biggest invoices or maybe the frustrating ones that have been hanging around for a while.
• Share the invoices with the factoring company: They'll look at details like your customer's credit and how much the invoices are worth, then come back with an offer, usually within a couple of days.
• Receive the factoring payment: Once you give the factoring company the green light, things move fast. You could have 80% to 90% of the cash in your account within 24 to 48 hours.
• Customers submit invoice payments: Your customers won't notice much difference. They'll pay their invoice normally but send payments to the factoring company instead of you.
• Receive the final payout: After your customers pay, you'll get the rest of what the factoring company owes you, minus the fee.

Invoice Factoring Example

How finance factoring works is easier to understand with a real-world example. Imagine you just wrapped up a $20,000 project — maybe it's a big website design or a major equipment installation. Your customer has a 60-day window to submit payment, but you're a little short on cash and need to make payroll.

This is where small business factoring services step in. Instead of your cash flow statement taking a hit, you could get $18,000 (90% of the invoice) in your account ready to use right away.

Here's what that might look like in this situation:

In the end, you get $19,400 instead of the full $20,000. The $600 fee to the factoring company is the cost of getting your money when you need it rather than when your client decides to pay.

Is Invoice Factoring a Good Idea for My Business?

Deciding if it's the right choice comes down to your specific needs and priorities. If accessing working capital helps you take on another big project, stock up on materials at a discount, or simply sleep better at night knowing payroll is covered — many business owners would say yes. Still, every financing option has its trade-offs. Let's consider the advantages and disadvantages of invoice factoring.

Advantages of Invoice Factoring

• Improved cash flow: You get paid within days instead of waiting for your client to pay.
• Debt-free: Unlike traditional loans, factoring doesn't add debt onto your books.
• Easy approval: Factoring companies care more about your customers' ability to pay than your credit score.
• Scalable: As your sales grow, your available funding grows, too—no endless rounds of loan applications or begging your bank for a higher credit line.
• Time saver: The factoring company takes over the payment follow-up, giving you back those hours in your day.

Disadvantages of Invoice Factoring

• Higher cost: Expect to pay between 1% and 5% in fees. It's typically more than a traditional loan, but you're paying for speed and convenience.
• Customer relationships: Your customers will know you're using factoring since they'll send payments to someone else.
• Less control: Once you sell an invoice, you can't control how customer communications are handled.
• Hard habit: Stepping away can be challenging if your cash flow hasn't improved.

How Much Does Invoice Factoring Cost?

The amount you pay for invoice factoring depends on several factors, including your invoice amount and payment schedule, your customers' creditworthiness, and how long it takes them to pay.

Typically, you'll pay around 1% to 5% as a factoring fee. But total costs vary, and you might run into additional costs, including documentation fees, processing fees, carrier payments, buyout fees, early termination fees, servicing fees, and credit check fees. Always read the fine print to ensure you understand your costs before signing.

Alternatives to Invoice Factoring

Invoice factoring is just one option. But before you explore business financing, consider making a few process changes to help with cash flow:

• Send bills immediately: Have a rock-solid credit policy in place and get invoices out as soon as work is complete (rather than waiting until month-end). The sooner you bill, the sooner you get paid.
• Automate follow-ups: Set up automated nudges for payment reminders. Something like "Just a heads-up that invoice #123 is coming due" works wonders.
• Make it easy to pay: Give your clients payment options that work for them. Credit cards, ACH, digital wallets — the more ways they can pay, the faster you'll get paid.

If your business is still short on cash flow, here are funding alternatives to invoice factoring:

• Invoice financing: Accounts receivable financing using outstanding invoices as collateral while keeping complete control of customer collections and communication.
• Line of credit: Access flexible funding that lets you borrow what you need and pay interest only on the amount you use.
• Traditional loan: Bank loans can offer set payment terms and might come with lower interest rates.

Choose an Invoice Factoring Company for Your Business

Your business growth doesn't have to wait just because you have unpaid invoices. While invoice factoring isn't the only solution, it's a viable option if you need immediate working capital to keep your business running smoothly.

At Paychex, we understand that accessing working capital is about more than just getting paid — it's about having the freedom to support your team, seize new opportunities, and grow your business on your terms. Let's explore invoice factoring services to turn slow-paying invoices into immediate capital.