How invoice factoring works.

The mechanic, in order

You deliver goods or services to a commercial customer and raise an invoice on net-30, net-45 or net-60 terms. That invoice is an asset: a legally enforceable claim on a business that owes you money. Factoring converts it to cash now.

1. You assign the invoice to a factor.
2. The factor advances a percentage of its face value — the advance rate — usually within a day or two.
3. The balance is held as a reserve.
4. Your customer pays the invoice, on their own schedule, to the factor.
5. The factor releases the reserve to you, less its discount fee.

A worked example

Take a $100,000 invoice on net-45 terms, an 85 per cent advance rate and a discount fee of 2 per cent for the first thirty days plus a further 0.5 per cent per ten days thereafter. These figures are illustrative of a common structure, not a quotation.

You received $97,000 for a $100,000 invoice, forty-three days earlier than you otherwise would have. Whether that is good value depends entirely on what you did with the money in those forty-three days. If it funded a job that produced margin, it was cheap. If it sat in the account, it was expensive.

Factoring buys time, and time is only worth what you do with it. This is the one financing instrument where the return is almost entirely in your hands.

The four terms that decide everything

1. Advance rate

The share paid up front, commonly 80 to 92 per cent depending on industry and debtor quality. Staffing and transport, where the receivable is clean and disputes are rare, sit at the top of that band. Construction, where retainage and progress claims complicate collection, sits at the bottom or is declined outright.

2. Discount fee and how it accrues

Two shapes exist. A flat fee is charged once per invoice regardless of how long it takes to pay — simple, and punishing on fast-paying customers. A time-based fee accrues per ten, fifteen or thirty days outstanding — more complex, and cheaper if your debtors are prompt. Ask which one is on the table and model both against your actual days-sales-outstanding, not the terms printed on your invoices.

3. Notification or non-notification

In a notified facility your customer is told the invoice has been assigned and pays the factor directly. This is standard and, in industries where factoring is routine, entirely unremarkable to your customers. In a non-notified (confidential) facility your customer keeps paying you into an account the factor controls. It costs more and requires stronger credit. If you fear the optics, ask peers in your sector first — in freight and staffing the perception concern is usually imaginary.

4. Recourse or non-recourse

This is the one that surprises people. Under recourse factoring — the great majority of the market — if your customer never pays, you buy the invoice back. The credit risk stayed with you the whole time. Non-recourse factoring costs more and covers you, but typically only against your customer’s formal insolvency. If the customer is solvent and simply disputing the work, that is not covered under most non-recourse agreements. Read the definition of the covered event, not the label on the front page.

What underwriting actually looks at

Because the collateral is your ledger, the credit assessment points largely at your customers rather than at you. Expect attention on:

• Debtor concentration. One customer at seventy per cent of the ledger is a risk to the factor even if that customer is excellent. Expect a concentration limit.
• Debtor credit quality. The factor will run your customers. A blue-chip debtor book improves your terms more than your own financials do.
• Dilution. The proportion of invoiced value that never gets collected — credit notes, short payments, returns, disputes. High dilution suppresses the advance rate directly.
• Ageing. Invoices already past ninety days are usually excluded from the borrowing base entirely.
• Existing liens. An earlier general lien over receivables must be released or subordinated before a factor can take first position.

When factoring is the wrong tool

Factoring solves a timing problem: profitable work, slow payers. It does not solve a margin problem. If your jobs are not profitable before financing costs, moving cash forward at a discount accelerates the loss rather than fixing it.

It also fits badly where invoicing is milestone-based with claw-back provisions, where you sell to consumers rather than businesses, or where a facility minimum forces you to factor invoices you did not need to. That last one is worth checking in the agreement: monthly minimum volumes, and the fee charged for falling short of them.

If the gap is really about buying inventory or covering payroll ahead of a season rather than about collection speed, a working capital facility may fit better. If it is about a machine, see equipment finance. To get a ledger ready for review, start with what underwriters review, or send the desk an ageing report.