What is invoice factoring?

Invoice factoring is a financing arrangement where a business sells its outstanding invoices to a factor, which advances a percentage of the face value up front and releases the rest, minus fees, once the customer pays. It converts future receivables into immediate cash, at the cost of a percentage point or two off the top of each invoice.

Factoring is most common in industries with long payment terms and reliable but slow-paying customers, like trucking, staffing, and manufacturing. Many small businesses use factoring as a bridge during fast growth, when the working-capital gap between paying suppliers and collecting from customers would otherwise stall them. It is not a solution to a collections problem; it is a solution to a timing problem.

The tradeoff is the fee and the loss of direct control over the customer relationship, since some factoring arrangements have the factor collect directly. Before turning to factoring, many businesses find that tightening their own collections process, shortening DSO by a couple of weeks, removes enough of the pressure that expensive outside financing stops being necessary.