What Is Factoring?
Factoring is a form of receivables finance in which a company sells its unpaid invoices to a factor rather than waiting for customers to pay. Because the invoices are sold outright, factoring is legally a purchase of assets rather than a loan, and the factor generally takes over collecting from the company's customers. This distinguishes it from a receivables-backed credit line, where the invoices merely serve as collateral.
Arrangements come in two main forms. Under recourse factoring, the seller must buy back or replace any invoice the customer fails to pay, so the seller keeps the credit risk. Under non-recourse factoring, the factor absorbs losses from customer insolvency and charges a higher fee for doing so. The structure is common in industries with long payment cycles, including trucking, staffing, apparel, and wholesale distribution.
How Factoring Works
The factor typically advances 70% to 90% of an invoice's face value as soon as it is submitted. When the customer pays, the factor remits the remaining balance minus its fee, which commonly runs 1% to 5% of invoice value depending on volume, customer credit quality, and how long the invoice stays outstanding. The factor evaluates the creditworthiness of the company's customers, since they are the ones who ultimately pay.
Take a $100,000 invoice with an 85% advance rate and a 3% fee. The company receives $85,000 immediately; when the customer pays in 60 days, the factor keeps $3,000 and remits the final $12,000. That 3% charge for 60 days of financing works out to an annualized cost above 18%, which is why factoring is usually more expensive than bank credit.
Why Factoring Matters
For fast-growing or thinly capitalized businesses, factoring provides liquidity that scales automatically with sales, since more invoices mean more available funding. It can also serve as an outsourced credit and collections department, which is valuable for small companies selling to large customers on extended terms. Because approval depends mostly on the customers' credit rather than the seller's, companies that cannot qualify for traditional loans can often still factor.
Analysts pay attention when a company factors its receivables, both because the cost is high relative to other financing and because sold receivables can flatter reported working capital metrics. In credit and restructuring work, understanding whether receivables have been factored — and whether the arrangement is recourse or non-recourse — matters for mapping who actually owns the assets and bears the collection risk.
