Invoice factoring: what it costs and when to avoid it

On this page

• How factoring works
• What factoring costs: a worked example
• Contract terms that change the cost
• When factoring fits
• When factoring is a bad idea
• Factoring or invoice financing
• Questions to ask a factor

How factoring works

In factoring, you sell unpaid invoices to a factor at a discount. The factor pays you for them, collects from your customer, and keeps a fee out of what it collects. The Federal Reserve Board describes it this way. It also notes that factoring offers typically do not state a cost as an interest rate or APR.

The OCC's handbook describes bank-style factoring. The factor buys the invoices at a discount, usually without recourse, and takes the credit risk on the accounts it buys. Customers are told to pay the factor directly (p. 33). The factor focuses its due diligence on your customer's credit more than on yours. Small business contracts vary, so check yours.

Under UCC § 9-406(a), once your customer receives notice of the assignment, paying you no longer settles the debt. Only paying the factor does. Read the recourse clause first, because it decides who bears a customer's non-payment.

In the Federal Reserve Banks' 2026 survey, 3% of employer firms sought factoring in the prior 12 months. Providers state prices in different ways, which makes comparison harder.

What factoring costs: a worked example

Suppose you factor a $20,000 invoice. Assume the factor advances 80% and charges 2% of the invoice for the first 30 days, plus 0.5% for each added 10 days. This is an illustration, not a quote.

• Advance: $20,000 × 80% = $16,000.
• Your customer pays on day 50, which is 20 days past the first 30. Fee: 2% + (2 × 0.5%) = 3%, or $600.
• Rebate to you: $20,000 − $16,000 − $600 = $3,400.

The fee looks like 3%. Annualize it on the cash you actually received: ($600 ÷ $16,000) × (365 ÷ 50) = 3.75% × 7.3 = 27.4% a year.

The first 30 days carry a flat 2%, so paying faster raises the annualized cost. If your customer pays on day 30, the fee is $400. The annualized figure is ($400 ÷ $16,000) × (365 ÷ 30) = 30.4% a year, higher than the 27.4% at day 50.

Now test the margin. Suppose the invoice carries a 25% gross margin, which is $5,000. The $600 fee takes 12% of it. Factor every invoice at that price and a large part of your profit goes to the fee.

Now compare a line of creditline of creditA credit limit you can draw on, repay and draw on again. . Suppose a bank line charges 12% a year on the amount drawn. Borrowing $16,000 for 50 days costs $16,000 × 12% × 50/365 = $263. The factor's $600 fee is $337 higher. That $337 pays for what the factor adds: collection work and, in a non-recourse deal, protection against a customer's non-payment. Decide whether you need those services at that price.

Contract terms that change the cost

• Recourse. In a recourse deal, a customer's non-payment can be charged back to you. In a non-recourse deal, the factor takes the loss. Ask exactly which events the non-recourse promise covers.
• Notice. Your customer is told to pay the factor. Some owners dislike that.
• Minimums and length. Ask whether you must factor every invoice or a minimum volume, and what ending the contract costs. The Federal Reserve Board warns that offers can differ widely in fees and collateral requirements.
• Liens. A factor may file a lien on your receivables. A Working Capital CAPLine needs a first lien on your trading assets, including receivables (SOP 50 10 8.1, App. 19, Para. B.5.b). A factor's claim can conflict with that.
• Disclosure. California's disclosure rules cover commercial factoring. Covered providers must disclose the funding amount, the APR, the payment, the term and prepayment details (DFPI, June 14, 2022). New York requires covered providers to give an estimated annual percentage rate on factoring offers (Financial Services Law § 806). Other states differ.

Ask each factor for the estimated APR in writing, and how it was calculated.

When factoring fits

• You invoice businesses or agencies and wait a long time to be paid.
• Sales are growing faster than your cash. Each new order needs materials and payroll before its invoice pays.
• You have little else to pledge. A factor leans on your customers' credit, which can help a business with limited collateral.
• The need is short. Ask whether the factor buys single invoices or requires a long contract.

When factoring is a bad idea

• Thin margins. In the example, the fee took 12% of the invoice's margin. At lower margins it can take all of it.
• Slow customers. Fees grow as days pass, so slow payers cost the most in dollars.
• One customer is most of your sales. A factor sets a limit for each customer (OCC, p. 34). A business with one dominant customer may find that limit too small.
• Consumer sales. With no invoices, there is nothing to factor.
• Disputed invoices. A factor can reject receivables from an individual customer (OCC, p. 33). It also checks that you can absorb charge-backs and disputed accounts (OCC, p. 34).
• A planned SBA loan. SBA says factoring agreements are not eligible for refinancing, so an SBA loan cannot pay one off. The working capital part of an SBA loan cannot repay it either (Sec. A, Ch. 3, Para. A.2.d.iii). Plan your exit before you enter.

Factoring or invoice financing

Factoring is a sale of invoices. Invoice financing is a loan secured by them. In a loan you keep the invoices and the customer relationship, and a borrowing base limits what you can draw. The lender holds a lien and may control where payments land.

Neither is cheap money by default. Compare each on the same footing: total dollars paid, divided by dollars received, scaled to a year. Then compare both with a bank line of credit or an SBA Express line.

Questions to ask a factor

• What share of each invoice do you advance, and when do I receive the rest?
• What is the fee schedule by day, and does it start on the advance date or the invoice date?
• Is the deal recourse or non-recourse, and what does non-recourse cover?
• Must I factor every invoice, or a minimum volume?
• Which fees apply beyond the discount fee: setup, wire, audit or termination?
• Will you file a lien on only my receivables, or on all my assets?
• What is the estimated APR, and how did you calculate it?