Business Finance Guide · Cash Flow
Get paid this week, not in 60 days
How invoice factoring works, what it costs and the contract terms to watch.
Invoice factoring lets a business sell its unpaid customer invoices to a factoring company for cash now, instead of waiting 30, 60 or 90 days for customers to pay.
For businesses that sell to other businesses or to government agencies, waiting to be paid is normal. A trucking company, a staffing agency or a food distributor can deliver in full and still wait two months for cash while payroll and fuel are due every week. Factoring turns those invoices into cash within a day or two.
It is a niche product. In the Federal Reserve’s 2025 Small Business Credit Survey, 3% of employer firms sought factoring in the prior 12 months, compared with 29% that sought a credit card and 38% that applied for a loan, line of credit or cash advance. For the right business, it fills a gap that banks often will not.
What small firms sought in the past 12 months (2025)
Share of employer firms. Source: Federal Reserve Banks, 2026 Report on Employer Firms.
How invoice factoring works
The factoring process
- You deliver and invoiceYour customer owes you, for example, $50,000 due in 45 days.
- You sell the invoiceThe factoring company verifies it and advances a share, often 70% to 90%, within a day or two.
- Your customer pays the factorCustomers are told to pay the factoring company directly.
- You receive the restThe factor sends the remaining balance, minus its fee, once the customer pays.
A worked example
A Sacramento-area distributor factors a $50,000 invoice. The factor advances 85%, or $42,500, on day one and charges 3% of the invoice for each 30 days it is outstanding. The customer pays in 30 days.
Example: factoring a $50,000 invoice
Illustrative example. Rates, advance percentages and fee schedules vary by factor and industry.
A 3% fee sounds small, but it is charged on the full invoice for one month while you had $42,500 of the factor’s money. That is about 3.5% per month on the cash advanced, or roughly 43% on a simple annualized basis, and more if the customer pays late and extra fee periods apply. Factoring costs less than a merchant cash advance in most cases, but more than a bank line of credit.
Recourse vs. non-recourse
Types of factoring
| Recourse factoring | Non-recourse factoring | |
|---|---|---|
| If the customer never pays | You buy the invoice back or replace it | The factor absorbs the loss, usually only if the customer goes bankrupt |
| Cost | Lower | Higher |
| Approval | Easier | Depends heavily on your customers’ credit |
| Best for | Reliable customers who pay slowly | Large customers with credit risk |
Factoring vs. other options
Invoice-based financing compared
| Invoice factoring | Invoice financing / A/R line | Business line of credit | |
|---|---|---|---|
| Who collects from customers | The factor | You | You |
| Customers know | Usually yes | Usually no | No |
| Based on | Your customers’ credit | Your receivables and credit | Your business’s credit and cash flow |
| Speed | Days | Days to weeks | Weeks |
| Typical cost | Moderate to high | Moderate | Lowest |
Contract terms to read carefully
- Fee schedule: flat fee or a fee for every 10, 15 or 30 days the invoice is unpaid.
- Advance rate and reserve: how much you get up front and when the rest is released.
- Minimum volume: some contracts charge fees if you factor less than a set amount each month.
- Long terms and termination fees: look for month-to-month or short commitments.
- Factoring all invoices: some factors require every invoice from a customer, not only the ones you choose.
- Other fees: application, due diligence, wire, credit check and lien filing fees.
Under California’s commercial financing disclosure law (SB 1235), factoring providers must disclose the amount funded, the total dollar cost, the term, the payment terms and prepayment policies before you sign, using an example transaction when needed. Use those numbers to compare offers.
When factoring makes sense
- You sell to creditworthy businesses or government agencies that pay slowly.
- Your business is growing fast and invoices outpace the cash to fund new orders.
- Your business is young or your credit is thin, but your customers are strong.
- Your gross margins can absorb a 2% to 5% cost per month an invoice is outstanding.
Factoring is a poor fit for thin-margin businesses, for retail sales to consumers and as a permanent fix for a business that is not profitable. Build a cash flow forecast first to see whether a line of credit or better payment terms could close the gap more cheaply.
Factoring also works best when it is part of a plan. Many growing businesses factor for a year or two while they build profits, a payment history and business credit, then move to an accounts receivable line of credit or a conventional bank line at a lower cost. Set a goal for when you want to make that switch, and ask your bank what it would need to see.
What factors look for
Factoring decisions focus on your customers more than on you. A factor checks that each customer is creditworthy, that the invoice is for goods delivered or services completed and that nothing, such as an existing lien, prevents the sale. Invoices to large, established companies and government agencies are the easiest to factor. Invoices that depend on future work, include disputes or are far past due are hard to place.
Expect the factor to file a UCC lien on your receivables and to check whether another lender already has one. If you have a bank line of credit secured by all business assets, you may need the bank’s consent before factoring.
Questions to ask before you sign
- What is the advance rate, and when is the reserve released?
- How is the fee calculated, and what happens if a customer pays late?
- Is the agreement recourse or non-recourse, and what does non-recourse cover?
- Is there a minimum monthly volume or a long-term commitment?
- What other fees apply, and what is the cost to end the agreement?
- How will the factor communicate with my customers?
Common mistakes
- Focusing only on the advance rate. A higher advance with higher fees can cost more overall.
- Ignoring how the factor treats customers. Collection practices reflect on your business.
- Signing a long contract to test the service. Start with a short or month-to-month term.
- Factoring forever. As your credit and history grow, move to a cheaper bank line of credit.
Key terms
- Advance rate: the percentage of the invoice paid to you up front.
- Reserve: the share held back until the customer pays, minus the factor’s fee.
- Recourse: your obligation to buy back an invoice the customer does not pay.
- Notice of assignment: the letter telling your customer to pay the factor.
- Spot factoring: factoring a single invoice rather than an ongoing account.
The bottom line: invoice factoring is a practical bridge for growing businesses with strong customers and slow payment cycles. Know the full cost, choose flexible terms and plan your path to lower-cost credit as the business matures.
Free help in the Sacramento region
You do not have to work through these decisions alone. SCORE Sacramento pairs owners with volunteer mentors, many of them retired executives, bankers and accountants, at no cost. The Sacramento Valley Small Business Development Center offers free one-on-one advising on financing, budgeting and financial statements. The SBA’s Sacramento District Office can explain loan programs and connect you with lenders, and community lenders such as California Capital and Opening Doors serve owners who need smaller loans or extra support. Browse our Business Resources and the free business help guide for more.
Key takeaways
- Invoice factoring sells unpaid invoices for cash now, often 70% to 90% up front.
- In our example, a 3% fee for 30 days equals about 43% a year on the cash advanced.
- Recourse factoring is cheaper; non-recourse shifts some customer credit risk to the factor.
- Only 3% of small firms sought factoring in 2025, but it suits fast-growing B2B and government contractors.
- Read fee schedules, minimums and termination terms before signing.
Frequently asked questions
Is invoice factoring a loan?
No. Factoring is the sale of your invoices to a factoring company. You do not repay it like a loan; the factor collects from your customers.
How much does invoice factoring cost?
Fees commonly run from about 1% to 5% of the invoice for each month it is outstanding, plus possible service fees. The annualized cost is usually much higher than the monthly rate suggests.
Will my customers know I am factoring?
Usually yes, because customers are told to pay the factoring company. Invoice financing, where you keep collecting, can keep the arrangement less visible.
Can a new business use factoring?
Yes. Factors focus mainly on your customers’ ability to pay, so young businesses with strong customers can often qualify.
Can government contractors factor invoices?
Yes. Some factors specialize in government receivables, which can help small contractors waiting on agency payment cycles.
Sources
- Federal Reserve Banks: 2026 Report on Employer Firms (2025 Small Business Credit Survey)
- California DFPI: Commercial financing disclosures (SB 1235)
- SBA lender resources: 7(a) loan types including CAPLines and Express
- SBA: Loans
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- How to Choose a Business Structure in California: Sole Proprietorship, LLC, S Corp or C Corp
- Business Banking 101: How to Choose and Open a Business Bank Account
- Small Business Funding Options: Loans, Grants and Investors
- Business Resources: all guides →
