A business can be profitable on paper and still run out of cash — the classic small-business trap of having $40,000 in unpaid invoices due in 60 days while payroll is due Friday. Invoice factoring exists specifically to close that gap.
How It Works
A factoring company buys your unpaid invoices at a discount and pays you a large advance immediately — typically 70% to 95% of the invoice value, with some arrangements advancing up to 100% — instead of you waiting the full 30, 60, or 90 days for your customer to pay. When your customer eventually pays the invoice, the factoring company releases the remaining balance to you, minus their fee. Funding is usually fast, often within 24 to 48 hours of approval, which is the whole point: converting a receivable you already earned into cash you can use today.
What It Costs
Factoring fees typically run 0.5% to 3% of the invoice value, but because that fee applies over a short holding period (weeks, not a year), the effective annualized cost is much higher — commonly 18% to 45% in APR terms once you convert the per-invoice fee into an annual rate. That’s meaningfully more expensive than a traditional line of credit, which is the real tradeoff: factoring is fast and doesn’t require the credit history a bank loan does, but it costs more for the convenience.
Who Actually Uses It
Factoring is most common in industries with long payment cycles and B2B invoicing — staffing, transportation and logistics, manufacturing, wholesale, and professional services are the heaviest users. It’s a natural fit for a growing business whose sales are outpacing the cash actually landing in the bank, since factoring scales with invoice volume rather than requiring a fixed loan approval each time.
When It Makes Sense (and When It Doesn’t)
Factoring makes sense as a bridge for a real, temporary cash flow gap — covering payroll or supplier payments while waiting on invoices you’re confident will be paid. It makes much less sense as an ongoing substitute for fixing the underlying problem: slow-paying customers or payment terms that don’t match your own bills. If the gap is chronic rather than occasional, a business line of credit is usually the cheaper long-term tool, with factoring reserved for the invoices a bank line won’t cover fast enough.
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