What Is Invoice Factoring? A Guide for Contractors

You have the skills and the team to take on bigger, more profitable projects, but one thing consistently holds you back: working capital. When your money is tied up in unpaid invoices with 30, 60, or 90-day terms, you can’t confidently purchase the materials or cover the labor needed to expand. It’s a frustrating cycle that stalls even the most ambitious trade businesses. Invoice factoring is a financial strategy designed to break this cycle. By selling your outstanding invoices for immediate cash, you get the fuel needed to bid on bigger jobs and grow your company on your own terms.

Waiting on customers to pay their invoices off can have a snowball effect on your company’s finances, holding you up from making essential payments on payroll, utilities, inventory, and more. Along with a disruption to day-to-day operations, unpaid invoices can also prevent you from investing in new business growth opportunities or taking on more jobs. To keep things moving smoothly, invoice factoring can alleviate the stress of that cash crunch and help you maintain success. So what exactly is invoice factoring and how does it work? Let’s dive in.

What Is Invoice Factoring?

Invoice factoring is a type of financing where you sell your unpaid customer’s invoices to a factoring company in exchange for immediate cash upfront. It’s considered a sale, not a loan, so it never affects your credit score and is an ideal option for small business owners. This way, they can get the money they need without having to wait for customers to pay off their remaining balance.

Alternative Names for Invoice Factoring

You might hear invoice factoring called a few different things, but they all point to the same financial tool. The most common alternative is “accounts receivable factoring,” and you may also see it referred to as “debt factoring.” While the names vary, the process is straightforward: you sell your unpaid customer invoices to a third-party company, known as a factor, in exchange for immediate cash. This isn’t a loan; it’s an advance on money you’re already owed. Understanding how it works is key, as it allows you to turn your outstanding receivables into working capital almost instantly. For a growing trade business, this quick access to funds can be the difference between taking on a new project and being stuck waiting for clients to settle their accounts.

How Does Invoice Factoring Work?

Here’s the rundown:

1. Once a business owner provides goods or services, the invoice is sent to the customer.
2. The invoice is also sent to the factoring company.
3. Depending on the factoring agreement, the business owner will receive a cash advance for approximately 80-90% of the invoice amount.
4. The factoring company is now responsible for collecting payment from the customer.
5. Once the invoice is paid, the factoring company will release the remaining 10-20% of the invoice to the business owner, minus a factoring fee.

Let’s see an example: Say you own an HVAC company and just installed two new AC units for a local retail store, creating a $10,000 invoice that your customer agrees to pay off within 30 days. Since you need the cash immediately to start on your next job, your invoice factoring company buys the invoice off for $9500 cash with a 5% factoring fee ($500). The invoice factoring company advances 80% of the invoice ($7,600) so you can have cash in a few business days. 30 days later, they collect the invoice from your customer and pay you the remaining balance ($1,900).

Key Invoice Factoring Terms to Know

Understanding invoice factoring involves being familiar with key terms:

• Approval period: The agreed-upon period that the customer will pay off their invoice. Any unpaid debt will be recouped by the business owner, sometimes along with refactoring fees.
• CHOCC factoring: Client Handles Own Credit Control (CHOCC). In this case, the business owner is responsible for collecting payment rather than the factoring company.
• Confidential factoring: Keeps the factoring company completely confidential from the customer who owes the invoice.
• Disbursements: Additional fees charged by the invoice factoring company, such as credit checks, admin errors, receiving letters, expedited bank payments, etc.
• Disclosed factoring: The customers are made aware that they are dealing with an invoice factoring company.
• Non-recourse factoring: If the customer fails to make the invoice payment, then the factoring company will take responsibility for the loss. This creates a lower risk for the business owner but typically comes with a higher factoring fee.
• Payment terms: Refers to the agreed timeframe that the customer has to pay off their invoice. The most common payment terms are 30, 60, and 90 days, but this can vary depending on the factoring company and the customer’s contract.
• Selective factoring: A type of invoice factoring where they bundle smaller amounts together or are individual rather than a large amount or the entire sales ledger.
• Spot factoring: This allows invoices to be factored individually.

Types of Invoice Factoring

Not all invoice factoring agreements are created equal. The right one for your business depends on how often you face cash flow gaps and how much flexibility you need. For contractors, where one month might be packed with small residential jobs and the next dominated by a single large commercial project, understanding these differences is key. Choosing the right type of factoring can mean the difference between simply getting by and having the working capital to confidently bid on bigger jobs. Let’s look at the three main options to see which one aligns with your business goals.

Spot Factoring

Think of spot factoring as a one-time cash injection. It allows you to sell a single invoice to a factoring company without any long-term commitment. This is perfect for when you have an unexpectedly large invoice and need the cash immediately to cover project costs or purchase materials for the next job. For example, if your HVAC company just finished a major installation and you need funds to buy a new service vehicle, you could factor that one invoice to get the cash quickly. Spot factoring offers maximum flexibility, making it a great tool for managing working capital on an as-needed basis without being locked into a contract.

Selective Factoring

Selective factoring is the happy medium between a one-off transaction and a full-time commitment. With this approach, you can choose which of your invoices you want to factor. This gives you more control over your cash flow, allowing you to sell invoices from clients who typically take longer to pay while continuing to collect directly from your faster-paying customers. Imagine you’re an electrical contractor with several invoices out. You could decide to factor the invoices from a large commercial client with 90-day payment terms, while keeping your residential invoices (with 30-day terms) to manage yourself. This strategy helps you maintain a steady cash flow without handing over your entire accounts receivable.

Whole Ledger Factoring

Whole ledger factoring is a more comprehensive solution where you agree to factor all of your business’s invoices with one company. This creates a consistent and predictable stream of cash, turning your accounts receivable into a reliable source of immediate funding. This option is ideal for growing businesses that need continuous capital to manage payroll, invest in new equipment, and take on more projects. By ensuring you always have cash on hand, you can focus on what you do best—running your business. Pairing this steady cash flow with a robust system for managing your inventory and purchasing ensures you can order parts and materials exactly when you need them, keeping your jobs on schedule and profitable.

Is Invoice Factoring Right for Your Business?

Every business owner should thoroughly understand the role that invoice factoring can play in their financial journey and make a decision that will best suit their needs. Like any financial business decision, invoice factoring has pros and cons that can vary depending on the business itself. Let’s go over them to help you weigh your options.

Who Should Use Invoice Factoring?

Invoice factoring isn’t a one-size-fits-all solution, but it’s a game-changer for certain types of businesses. If you find yourself nodding along to any of the descriptions below, it might be the right financial tool to help you manage your cash flow and keep your business running without a hitch.

Businesses Selling to Other Businesses (B2B)

Invoice factoring is specifically designed for companies that sell to other businesses (B2B) or the government (B2G). The entire process hinges on the factoring company collecting payment from your business customer. Because of this structure, this type of financing isn’t an option for companies that sell directly to individual consumers (B2C), as collecting from individuals is a completely different ballgame.

Contractors in the Trades

While many industries use factoring, it’s especially common in the trades. Businesses in transportation, manufacturing, and staffing often rely on it, as do contractors in HVAC, plumbing, and electrical fields who need consistent cash flow to buy materials for the next job. When you’re waiting on a big payment but have to purchase supplies to get the next project started, factoring can bridge that critical financial gap and prevent project delays.

Startups or Businesses with Poor Credit

It’s often easier to qualify for factoring than a traditional bank loan. Factoring companies are more interested in your customers’ creditworthiness and ability to pay than your own credit history. This makes it a great option if you’re a new business still building your financial reputation or have a less-than-perfect credit score that might disqualify you from other types of financing.

Companies Without Other Collateral

Unlike a traditional loan, you don’t need to put up assets like property or equipment as collateral. With invoice factoring, the invoices themselves serve as the collateral, which greatly simplifies the approval process. This is a huge advantage for service-based businesses or newer companies that may not have significant physical assets to offer as security for a loan.

The Upside of Invoice Factoring

• Quicker and cheaper: Invoice factoring is much cheaper than taking out a bank loan. They’re also faster to obtain, making them ideal for short-term funding.
• Reduces stress and burden: Hiring an invoice factoring company can reduce the workload put on your employees. Instead of wasting valuable company time chasing invoice payments down, they can remain focused on valuable tasks while the factoring company takes matters into its own hands.
• Predictable cash flow: Invoice factoring pays the invoices off that are weighing you down and preventing money from coming in. This makes it easier to plan and predict the next business opportunity and have the finances to back up your decisions.
• Strengthens your business: Without adequate cash flow, many businesses fail. Invoice factoring helps alleviate financial pressures and issues. This allows you to continue operating without interruption, building a stronger, more dependable company.

Potential Downsides to Consider

• Recourse can be costly: Depending on your budget and the reliability of your customers, recoursing and refactoring fees could add up. If you know your customers have a history of not paying back invoices, this might not be the right option. There’s always non-recourse factoring as well, but it tends to cost more out the gate.
• Additional fees: Invoice factoring companies typically charge additional fees for various services, including wire transfers, returned checks, and late collections. It’s essential that you understand your company’s budget and if a factoring company will fit your needs.
• It’s a commitment: Invoice factoring contracts don’t typically let you switch the services on and off frequently, which means you’re in it for the long haul. Every customer’s contract is different, but factoring companies will want to help you manage the bulk of your invoices rather than a few here or there despite spot or selective factoring options. Make sure that the length of your contract is fit for your company before committing.

Loss of Control Over Customer Relations

Handing over your invoices means you’re also handing over a piece of your customer communication. The factoring company takes charge of the collections process, which means they’ll be the ones contacting your clients for payment. While this frees up your time, it’s a trade-off. If their collection style is more aggressive than yours, it could strain the good relationship you’ve worked hard to build. It’s crucial to vet the factoring company’s communication practices to ensure they align with your own business values and won’t jeopardize future jobs with that client.

It Doesn’t Solve All Financial Problems

Think of invoice factoring as a specialized tool in your financial toolkit, not a cure-all. It’s designed for one specific job: bridging the cash flow gap created by slow-paying clients. It gets you the money you need to cover immediate operational costs like payroll or materials for the next project. However, it’s not the right tool for long-term growth investments, like purchasing a new fleet of trucks or buying a larger workshop. For those major capital expenses, a traditional business loan is a more appropriate and cost-effective solution.

Risk of Losing the Factoring Company

Your relationship with a factoring company is a two-way street, and it hinges on the reliability of your customers. The factor is essentially betting on your clients’ ability to pay their invoices on time. If you have a portfolio of customers who consistently miss payment deadlines, the factoring company might see your business as too risky. They could choose to terminate your agreement, leaving you suddenly without that source of immediate cash flow. This makes it incredibly important to assess your clients’ payment histories before you decide to rely on factoring as a core part of your financial strategy.

What Does Invoice Factoring Cost?

While invoice factoring provides quick access to cash, it’s not free. Understanding the costs involved is key to deciding if it’s a profitable move for your business. The fees can seem complex at first, but they generally break down into a few key components. You’re paying for the convenience of getting your money now instead of waiting weeks or months, and that convenience comes at a price. Let’s look at what you can expect to pay and the factors that will influence your final rate so you can make an informed decision.

Typical Factoring Fees and Rates

The primary cost is the factoring fee, also known as the discount rate. This is the percentage of the invoice value that the factoring company keeps as their payment. This fee typically ranges from 1% to 5% of the total invoice amount. On top of that, some companies may charge a separate service or processing fee, which can add another 0.5% to 2.5%. For example, on a $10,000 invoice with a 3% factoring fee and a 1% service fee, your total cost would be $400. Always ask for a full breakdown of all potential fees before signing an agreement.

Factors That Influence Your Rate

The rate you’re offered isn’t arbitrary; it’s based on the level of risk the factoring company is taking on. Several key elements come into play. The total dollar value and volume of your invoices are big ones—the more business you bring them, the better your rate might be. But the most critical factor is your customers’ creditworthiness and payment history. If your clients are large, stable companies with a track record of paying on time, you’ll be seen as a lower risk and will likely secure a more favorable rate. The factor is more concerned with your customer’s ability to pay than your own credit score.

Why Quick Customer Payments Save You Money

With invoice factoring, time really is money—and the faster your customers pay, the more money you keep. Most factoring fees are calculated on a tiered schedule based on how long an invoice is outstanding. For instance, a 2% fee on a $10,000 invoice costs you $200 if your client pays within 30 days. But if that same client takes 90 days to pay, the fee could jump significantly, potentially costing you $600 or more. This structure incentivizes you to work with clients who have a history of prompt payments, as it directly impacts your bottom line and the total cost of using the service.

Factoring vs. Loans: A Cost Comparison

When you compare the costs, invoice factoring is almost always more expensive than a traditional bank loan. You’re paying a premium for speed and convenience. While a 3% factoring fee might not sound like much, it’s important to calculate the annual percentage rate (APR) to get a true comparison. Because the fee applies to a short period (like 30 or 60 days), the equivalent APR can be quite high. A bank loan will have a lower interest rate, but it comes with a lengthy application process and stricter credit requirements. The right choice depends on how urgently you need the cash.

Other Potential Fees to Be Aware Of

The factoring fee isn’t the only cost you need to watch for. It’s essential to read the fine print of your agreement, as some companies include a variety of additional charges. Be on the lookout for setup fees to initiate the service, monthly minimums if you don’t factor enough invoices, and extra service charges for things like credit checks, wire transfers, or processing payments. Don’t be afraid to ask for a complete and transparent list of all potential costs. A reputable factoring partner will be upfront about their fee structure, ensuring there are no surprises down the road.

Invoice Factoring vs. Financing: Which Is for You?

Although they sound similar, invoice factoring and invoice financing are two separate things that differ based on who is ultimately collecting payment on your invoices. With invoice factoring, the factoring company will remain in control of collecting the payments on the invoices they’ve purchased, whereas, with invoice financing, you retain control of collecting payments. Your business’s creditworthiness is also a significant consideration with invoice financing, while with invoice factoring, your client’s credit is the priority. Additionally, invoice factoring and financing differ when it comes to borrowing. Invoice financing typically requires you to repay your loans before borrowing again, whereas with invoice factoring, you can factor approved invoices sent to clients regardless of your outstanding loans.”

Getting Started: The Application Process

What You’ll Need to Apply

Getting approved for invoice factoring is usually a quick process, especially if you have your paperwork ready. You’ll need to provide a few key documents to get started. Be prepared to share an accounts receivable aging report (a list of all your unpaid invoices), proof of a business bank account, your company’s tax ID number, and some personal identification. This documentation helps the factoring company assess your business’s financial health and your customers’ creditworthiness—the most important factors for approval. Unlike a traditional loan application that scrutinizes your credit history, a factoring company is more interested in your customers’ track record for paying their bills on time. Having this information organized will make the application process much smoother and help you get the cash you need for your next job without delay.

How to Choose the Right Factoring Company

Most invoice factoring companies are industry-specific, which is important to take into consideration when searching for one that’s right for you. A factoring company that understands your company’s needs will ultimately be beneficial to your success and will help make the process seamless. It’s also important to consider interest and advance rates. Lower interest rates will help you with your budget, and high advance rates will allow access to more of your money upfront. When budgeting, you should also get all the information about potential additional fees before signing a contract to prevent sticker shock when paying your factoring company. Business owners also have to choose between an independent company or a bank. Independent companies understand that you need to increase cash flow and will consider taking you on as a client even if a bank has turned you down. You may still qualify for factoring if you have creditworthy customers. Banks offer the same flexibility as independent companies but may not have industry-specific knowledge and services. On the other hand, banks have their own source of funds, making it easier for them to offer competitive rates.

Common Misconceptions About Invoice Factoring

Invoice factoring often gets a bad rap, surrounded by myths that can make business owners hesitant. But many of these ideas are outdated or just plain wrong. Let’s clear the air and look at what invoice factoring really is—and what it isn’t—so you can decide if it’s a good fit for your business.

Myth: It’s a Last Resort for Failing Companies

One of the biggest misunderstandings is that factoring is a lifeline for businesses on the brink of collapse. In reality, many healthy, fast-growing companies use it as a strategic tool to manage their finances. For contractors in the trades, waiting 30, 60, or even 90 days for a payment can stall progress. Factoring provides the immediate cash flow needed to purchase materials for the next job, cover payroll, and seize new opportunities without delay. It’s not about desperation; it’s about maintaining momentum and fueling growth in a proactive way.

Myth: It’s Just Another Type of Loan

This is a crucial distinction: invoice factoring is not a loan. When you factor an invoice, you are selling an asset—your accounts receivable—to a third party at a discount. Because it’s a sale and not a debt, it doesn’t show up on your balance sheet as a liability or impact your business credit score. This makes it an excellent option for businesses that may not qualify for a traditional bank loan or simply want to avoid taking on more debt. The focus is on the creditworthiness of your customer, not your own credit history.

Myth: It Will Damage My Customer Relationships

It’s completely understandable to worry about a third party contacting your hard-won clients. However, professional factoring companies understand that your customer relationships are vital. They act as a seamless extension of your business, handling collections with professionalism and care. Their success is tied to yours, so maintaining a positive relationship is in everyone’s best interest. Furthermore, many factoring arrangements can be confidential, meaning your customer continues to pay you directly, and they may never even know a factoring company is involved. It’s all about finding a reputable partner who values your client relationships as much as you do.

Making the Call on Invoice Factoring

Invoice factoring is a great financing option for business owners in the contracting industry. Instead of waiting around for cash, it allows you to start working on new projects and increase revenue. Although it has its advantages, it’s not always for everyone. It’s essential to know and understand your business needs, budget, and flexibility for invoice factoring to work efficiently. Before jumping head first and committing to an invoice factoring company, ensure you understand what type of contract and terms work best for your company. If done correctly, it can help expedite new projects and sources of income to continue growing and expanding your company.

Frequently Asked Questions

How is invoice factoring different from a business loan? Think of invoice factoring as selling an asset, not taking on debt. You’re selling your unpaid invoices to a third party for a fee to get immediate cash. Because it’s a sale, it doesn’t add a liability to your balance sheet or affect your business credit score. The approval process focuses on your customer’s ability to pay, not your own credit history, which is a key difference from the strict requirements of a traditional bank loan.

Will my customers know I’m using a factoring company? That’s entirely up to you and the type of agreement you choose. In a disclosed factoring arrangement, the company will communicate with your client to collect payment. However, many companies offer confidential factoring, where the process is invisible to your customer. They continue to pay you directly, and you simply pass the payment along to the factor. A good factoring partner will always prioritize your customer relationships and handle communications professionally.

What happens if my customer pays late or not at all? This depends on whether you have a recourse or non-recourse agreement. With recourse factoring, if your customer fails to pay, you are ultimately responsible for buying back the invoice. This is the most common and affordable option. Non-recourse factoring means the factoring company assumes the risk of non-payment, which protects you but comes with higher fees.

Can I choose which invoices to factor, or do I have to sell all of them? You have a lot of flexibility here. If you only need a one-time cash infusion for a specific project, you can use spot factoring to sell a single invoice. If you want more control, selective factoring lets you pick and choose which invoices to sell, which is great for managing clients with longer payment terms. Whole ledger factoring, where you sell all your invoices, is also an option for businesses that need a constant, predictable cash flow.

How fast can I expect to get paid after I submit an invoice? Speed is the main advantage of invoice factoring. Once you’re set up with a factoring company, you can typically receive the cash advance within 24 to 48 hours of submitting an approved invoice. This turns your 30, 60, or 90-day waiting period into immediate working capital you can use to cover payroll, buy materials, and take on your next job.

Key Takeaways

• Get Paid Immediately to Keep Jobs Moving: Invoice factoring turns your outstanding invoices into immediate cash, giving you the working capital to buy materials, cover payroll, and confidently bid on new projects without waiting for client payments.
• Access Funds Without Taking on Debt: Factoring is the sale of an asset, not a loan, so it won’t affect your credit score or add liabilities to your balance sheet. Approval is based on your customer’s credit history, making it a great option for growing businesses.
• Choose the Right Partner and Understand the Fees: Not all factoring companies are the same. Look for one that understands the trades, be clear on all costs from the discount rate to extra service charges, and decide if you’re comfortable with them managing customer communications.

Related Articles

• A Brief Guide to Invoice Factoring
• What is invoice factoring? | Ply
• What is invoice factoring? #2 | Ply
• What is invoice factoring? #3 | Ply
• What is invoice factoring? #4 | Ply