Factoring and invoice financing: when it saves your business, when it ruins it
Selling your receivables is a legitimate way to bridge cash-flow gaps. It is also a famously easy way to erode your margins. Here is the plain-language test.
Factoring and invoice financing let a business turn unpaid customer invoices into immediate cash. A factor advances you 80-90% of the invoice value today, in exchange for a fee and the right to collect from your customer when the invoice is due. Used thoughtfully, this smooths cash flow and funds growth. Used badly, it quietly eats your margin and makes you dependent on an expensive counterparty.
Factoring vs invoice financing
Factoring: the factor buys the invoice outright and collects from your customer themselves. Your customer knows they are paying the factor. Invoice financing (also called invoice discounting): the lender advances against the invoice but you remain the collector. Your customer sees nothing different.
Typical pricing
Advance rate: 80-90% of invoice value, paid within 24-48 hours. Fee: 1-5% of the invoice value, depending on invoice size, customer credit quality, and your volume. Effective APR when annualised: 15-50%. Not cheap money.
When it makes sense
Your customers pay in 60-90 days (common in B2B) but your costs (salaries, suppliers) are due in 7-30 days. Growing fast, where every new project needs working capital you do not yet have in retained earnings. Serving large, slow-paying creditworthy customers (public sector, enterprise).
When it is a trap
Using factoring to mask underlying unprofitability — if the invoices themselves are below your true cost basis, factoring just accelerates the loss. Becoming structurally dependent — if 100% of invoices are factored, you cannot easily stop, and the factor's pricing power over you grows. Customer concentration — one customer missing a payment can trigger clawbacks across many invoices.
The quiet downside
Factored customers are harder to upsell (your relationship is now mediated). Factoring records on your business credit can make future bank credit harder to obtain. Changing factors is painful (contracts often lock you in for 12-24 months).
Alternative: tiered credit terms
Offer 2% discount for 10-day payment and standard 60-day otherwise. Customers with cash will self-select into early payment; those without will take the full term. This often achieves most of factoring's benefit without the fees.
The test to apply
If factoring's effective cost is less than the gross margin of the deals it funds, and you can see a path to self-funded working capital within 24 months, it is a reasonable bridge. Otherwise, question whether the growth you are funding is actually profitable at that cost of capital.