{"id":208532,"date":"2025-07-15T09:26:16","date_gmt":"2025-07-15T16:26:16","guid":{"rendered":"https:\/\/www.nationalfunding.com\/blog\/?p=208532"},"modified":"2025-07-07T16:12:21","modified_gmt":"2025-07-07T23:12:21","slug":"how-invoice-factoring-works-and-when-it-makes-sense","status":"publish","type":"post","link":"https:\/\/www.nationalfunding.com\/blog\/how-invoice-factoring-works-and-when-it-makes-sense\/","title":{"rendered":"How Invoice Factoring Works and When It Makes Sense"},"content":{"rendered":"<p><span data-contrast=\"auto\">Invoice factoring is when a business sells the invoices owed to them at a discount to a third party called a factoring company<\/span><i><span data-contrast=\"auto\">,<\/span><\/i><span data-contrast=\"auto\"> and the factor company collects from the business\u2019s customer directly.\u00a0<\/span><span data-ccp-props=\"{&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">The business selling their invoices is not required to tell the customer, but the customer will receive a <\/span><a href=\"https:\/\/www.law.cornell.edu\/ucc\/9\/9-406\"><span data-contrast=\"none\">notification of assignment<\/span><\/a><span data-contrast=\"auto\"> from the factor company. It is a good idea for companies that use invoice factoring to let their customers know someone else will be collecting the money owed, as a way to avoid any surprises.\u00a0\u00a0<\/span><span data-ccp-props=\"{&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">The discount you sell the invoices for is called the factor rate and determines how much cash you get:<\/span><span data-ccp-props=\"{&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/p>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"1\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">Cash from invoice factoring = invoice total * factor rate<\/span><span data-ccp-props=\"{&quot;335559738&quot;:240}\">\u00a0<\/span><\/li>\n<\/ul>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"1\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"2\" data-aria-level=\"1\"><span data-contrast=\"auto\">For example: If you sell $100,000 for a factor rate of 5%, you\u2019d get $95,000.<\/span><span data-ccp-props=\"{&quot;335559739&quot;:240}\">\u00a0<\/span><\/li>\n<\/ul>\n<p><span data-contrast=\"auto\">Factoring an invoice is different from getting a <\/span><a href=\"https:\/\/www.nationalfunding.com\/small-business-loans\/\"><span data-contrast=\"none\">small business loan<\/span><\/a><span data-contrast=\"auto\"> because you\u2019re selling the invoices instead of borrowing money, meaning there is nothing to pay back. You still get financing, but instead of paying interest over time to a lender, the drawback with factoring is that the factoring company gives you less than the invoice amount based on the factor rate.<\/span><span data-ccp-props=\"{&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Your customer\u2019s business credit score and financial history are two of the things a factoring company looks at when deciding whether to offer financing, so make sure they\u2019re in the clear. If financial statements show a lack of cash flow or a low business credit score, the factoring company may reject buying the invoices due to a lack of confidence in being able to collect repayment.\u00a0\u00a0<\/span><span data-ccp-props=\"{&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Factoring invoices can be a good option in some cases, like when loan approval is unlikely, when time is of the essence, or when the business loan interest rate is higher than the proposed factor rate. But it\u2019s not the best option in many other cases. In this guide, we&#8217;ll explore how the process works, when it makes sense, and when to avoid using it.\u00a0<\/span><span data-ccp-props=\"{&quot;134233117&quot;:false,&quot;134233118&quot;:false,&quot;201341983&quot;:0,&quot;335551550&quot;:1,&quot;335551620&quot;:1,&quot;335559685&quot;:0,&quot;335559737&quot;:0,&quot;335559738&quot;:240,&quot;335559739&quot;:240,&quot;335559740&quot;:276}\">\u00a0<\/span><\/p>\n<h2 aria-level=\"2\"><span data-contrast=\"auto\">The Invoice Factoring Process<\/span><span data-ccp-props=\"{&quot;134245418&quot;:true,&quot;134245529&quot;:true,&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/h2>\n<p><span data-contrast=\"auto\">Factoring invoices is a 5-step process:<\/span><\/p>\n<ol>\n<li data-leveltext=\"%1.\" data-font=\"\" data-listid=\"2\" data-list-defn-props=\"{&quot;335552541&quot;:0,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[65533,0],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;%1.&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">A company invoices a customer.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<li data-leveltext=\"%1.\" data-font=\"\" data-listid=\"2\" data-list-defn-props=\"{&quot;335552541&quot;:0,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[65533,0],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;%1.&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">The company negotiates terms with a factoring company, including the factor rate and any additional fees or withholding amount (where the factoring company withholds a buffer in case of collection trouble).<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<li data-leveltext=\"%1.\" data-font=\"\" data-listid=\"2\" data-list-defn-props=\"{&quot;335552541&quot;:0,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[65533,0],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;%1.&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">The company with the invoice signs over the legal right to collect to the factoring company (like signing over a check to someone else).<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<li data-leveltext=\"%1.\" data-font=\"\" data-listid=\"2\" data-list-defn-props=\"{&quot;335552541&quot;:0,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[65533,0],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;%1.&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">The customer pays the factoring company.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<li data-leveltext=\"%1.\" data-font=\"\" data-listid=\"2\" data-list-defn-props=\"{&quot;335552541&quot;:0,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[65533,0],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;%1.&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">If any funding was withheld, the factoring company pays the original company any amount still due.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ol>\n<p><span data-contrast=\"auto\">It is an easy process and can help you get immediate cash to grow your business instead of having to track down customer payments.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<h2 aria-level=\"2\"><span data-contrast=\"auto\">When Invoice Factoring Makes Sense<\/span><span data-ccp-props=\"{&quot;134245418&quot;:true,&quot;134245529&quot;:true,&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/h2>\n<p><span data-contrast=\"auto\">Invoice factoring is a good idea when:<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"4\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">You have sales but can\u2019t get a traditional small business loan.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"4\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"2\" data-aria-level=\"1\"><span data-contrast=\"auto\">There\u2019s no time to wait for traditional bank approval processes.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"4\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"3\" data-aria-level=\"1\"><span data-contrast=\"auto\">Interest rates are higher than the proposed factor rate.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<p><span data-contrast=\"auto\">Invoice factoring makes sense when you can\u2019t get a traditional small business loan because of your credit score, lack of collateral, or another reason.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">A B2B kitchen equipment supplier to hotels that wants to start selling B2C or to restaurants can use invoice factoring for advertising, setting up an ecommerce store or showroom, and hiring new staff. Traditional lenders may decline their application as this business could be considered too risky to enter into a new market. In this situation, the equipment supplier could combine invoice factoring with <\/span><a href=\"https:\/\/www.nationalfunding.com\/small-business-loans\/inventory-financing-loans\/\"><span data-contrast=\"none\">inventory financing<\/span><\/a><span data-contrast=\"auto\"> to stock up on consumer items that work as loan collateral. This could make approval easier to come by, given the lower risk to the lender.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Factoring an invoice also makes sense for unexpected opportunities like buying a competitor that just announced they\u2019re going bankrupt. Because a traditional expansion loan with a large bank can take weeks, invoice factoring (which gets you the cash fast so that you can close the deal before someone else does) could be preferable.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Another good use of invoice factoring is paying off debt where the interest rate is higher than the factor rate:<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"3\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">A 1-year loan of $100,000 at 10% costs you about $10,000 in interest expense. This makes the total payback amount $110,000.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"3\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"2\" data-aria-level=\"1\"><span data-contrast=\"auto\">With a 5% factor rate on $110,000 worth of invoices, the cost would be $5,500, and you&#8217;d get $104,500 back.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<p><span data-contrast=\"auto\">Pro-tip: Make sure there are no curtailment penalties (prepayment penalties) so you don\u2019t lose the gains in fees.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Even though invoice factoring makes sense for these situations, there are drawbacks, which can sour business relationships and hold businesses back.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<h2 aria-level=\"2\"><span data-contrast=\"auto\">Times to Avoid Invoice Factoring<\/span><span data-ccp-props=\"{&quot;134245418&quot;:true,&quot;134245529&quot;:true,&quot;335559738&quot;:240,&quot;335559739&quot;:240}\">\u00a0<\/span><\/h2>\n<p><span data-contrast=\"auto\">The times to avoid invoice factoring include the following situations:<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"5\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"1\" data-aria-level=\"1\"><span data-contrast=\"auto\">You\u2019re not confident that your customer can pay.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"5\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"2\" data-aria-level=\"1\"><span data-contrast=\"auto\">You have plenty of cash on hand and future cash flow to fund operations.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<ul>\n<li data-leveltext=\"\u25cf\" data-font=\"\" data-listid=\"5\" data-list-defn-props=\"{&quot;335552541&quot;:1,&quot;335559685&quot;:720,&quot;335559991&quot;:360,&quot;469769242&quot;:[8226],&quot;469777803&quot;:&quot;left&quot;,&quot;469777804&quot;:&quot;\u25cf&quot;,&quot;469777815&quot;:&quot;multilevel&quot;}\" aria-setsize=\"-1\" data-aria-posinset=\"3\" data-aria-level=\"1\"><span data-contrast=\"auto\">There is already a strain on your customer relationship.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/li>\n<\/ul>\n<p><span data-contrast=\"auto\">When you have a strong relationship with a customer, but their industry is in a temporary downturn that will last a year or two, a small business loan will be better than invoice factoring. This is because the factoring company can come after you through a recourse agreement (recourse means you\u2019re responsible until the invoice is paid) if the customer doesn\u2019t pay.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">It\u2019s possible to negotiate what\u2019s called a non-recourse agreement, where they can\u2019t hold you liable when customers don\u2019t pay. This lowers your risk but will make the factor rates higher because it&#8217;s a higher risk for the factoring company.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">In terms of the next situation, you\u2019ll get less than the total invoice value when you use factoring. So, this type of financing doesn\u2019t make sense when you have more than enough cash on hand and stable future cash flows to cover expenses. If you\u2019re buying a $50,000 piece of equipment and have $100,000 in the bank, it doesn\u2019t make sense to give up 5% or more of an invoice\u2019s value by factoring when you can use cash.<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Another reason not to factor invoices is the possible strain on customer relationships. Once you assign the invoice to the factoring company, you don\u2019t control how they collect, and they could pester or harass your customer and damage the relationship.\u00a0<\/span><span data-ccp-props=\"{}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">Using invoice factoring can allow you to focus on operations and future growth instead of collecting payments, making it a great option to get cash fast in some situations. When you have time to go through the business loan approval process though, or if you already have decent cash on hand, invoice factoring won\u2019t make sense given the various drawbacks.<\/span><span data-ccp-props=\"{&quot;134233117&quot;:false,&quot;134233118&quot;:false,&quot;201341983&quot;:0,&quot;335551550&quot;:1,&quot;335551620&quot;:1,&quot;335559685&quot;:0,&quot;335559737&quot;:0,&quot;335559738&quot;:0,&quot;335559739&quot;:0,&quot;335559740&quot;:276}\">\u00a0<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Invoice factoring is when a business sells the invoices owed to them at a discount to a third party called a factoring company, and the factor company collects from the business\u2019s customer directly.\u00a0\u00a0 The business selling their invoices is not required to tell the customer, but the customer will receive a notification of assignment from<a class=\"excerpt-read-more\" href=\"https:\/\/www.nationalfunding.com\/blog\/how-invoice-factoring-works-and-when-it-makes-sense\/\" title=\"ReadHow Invoice Factoring Works and When It Makes Sense\">&#8230; Read more &raquo;<\/a><\/p>\n","protected":false},"author":40,"featured_media":208534,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[23],"tags":[],"class_list":["post-208532","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-finance-lending"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v25.8 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>How Invoice Factoring Works and When It Makes Sense - The Bottom Line by National Funding<\/title>\n<meta name=\"description\" content=\"Invoice factoring can get you money to operate your business faster than traditional loans. 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