Cash flow management is one of the most significant challenges for small and midsize businesses (SMBs), especially in periods like 2025. Costs and economic uncertainty are on the rise, delaying customer payments and putting extra pressure on businesses. A staggering 88% of SMBs reported unexpected cash flow issues in the past year, according to a recent report by Relay.
Invoice factoring is a flexible way to boost working capital and can be a useful tool in managing liquidity issues, but there are risks associated with it. If you’re considering invoice factoring for your small business, here’s what you should know, including how it works, its pros and cons and how to choose the best factoring company.
What Is Invoice Factoring?
Invoice factoring is a type of business financing that involves selling your outstanding invoices at a discount. Instead of waiting weeks or months for your customers to pay, it allows you to convert your accounts receivable into cash almost immediately.
This can prove invaluable when you’re having liquidity issues, especially if more traditional debt financing isn’t available. Qualification depends more on your customers’ creditworthiness than your own, and approval rates are often higher.
For example, say it takes you an average of 45 days to collect from your customers. That’s a long time to go without getting paid, especially since you probably incurred costs to deliver your product or service.
With invoice factoring, you could collect the majority of your outstanding invoices’ total value in a fraction of the time, generating the working capital you need to meet your obligations and keep your business running.
How Does Invoice Factoring Work?
The details of the invoice factoring process can vary slightly between factoring companies—also known as factors—but it generally involves the following:
- Apply for invoice factoring: The first time you work with an invoice factoring company, you’ll need to complete an application and set up your account. This can take several days, but subsequent transactions will be faster.
- Sell your invoices at a discount: Once approved, you can submit invoices for factoring. The factoring company will usually advance you between 70% and 90% of the total value. The exact percentage depends on factors like your customers’ creditworthiness, your industry and the provider.
- Factoring company collects: The factor typically takes responsibility for collecting payment for the invoices from customers.
- Receive remaining funds: Once the factoring company finishes the collection process, they’ll release the remaining balance of the invoices net of their fees. Invoice factoring fees often range from around 1% to 5% of the invoice value. (For example, FundThrough charges 2.2% to 3% per 30 days.)
Like your initial discount rate, your actual factoring costs depend on several factors, including the creditworthiness of your customers and your industry, since some may be considered riskier than others.
The time it takes your customers to pay can also play a role. Many invoice factoring companies use a tiered rate structure, such as 1% for every 10 days the invoice remains unpaid.
Costs can differ depending on whether your contract is recourse or non-recourse. With recourse factoring, you bear the risk of nonpayment. If the factor can’t collect from a customer, you have to buy back the invoice or replace it with one of equal value. With non-recourse factoring, the factor takes over that risk—in exchange for higher fees.
Invoice Factoring vs. Invoice Financing
Though you’ll sometimes see the terms used interchangeably, invoice factoring and invoice financing are technically two alternative financing methods that leverage your outstanding invoices to generate working capital.
Factoring invoices involves selling them to a factoring company in exchange for a cash advance. Meanwhile, invoice financing involves borrowing against them, effectively using them as collateral for a loan.
Typically, though, the only practical difference between the two is that with factoring, the factoring company is responsible for collecting from customers. With invoice financing, that responsibility stays with you.
Benefits of Invoice Factoring
Invoice factoring is a flexible financing tool that can prove valuable in certain situations. Here are some of its most significant advantages:
- Speeds up cash flow: Slow-paying customers can cause your company to suffer from cash flow issues even if it’s profitable on paper. Invoice factoring can help ensure you have the funds to meet your obligations.
- Faster and easier than loans: Unlike traditional loans, approval for invoice factoring depends more on your customers’ creditworthiness than your own, making it more accessible for companies with limited or bad credit. Turnaround times also tend to be faster, with some factors even offering same-day funding.
- No debt on the balance sheet: Because invoice factoring technically involves selling your accounts receivable in exchange for immediate cash, it doesn’t count as a traditional liability. Keeping debt off the balance sheet can make your financial position appear stronger.
Risks of Invoice Factoring
While invoice factoring has its use cases, it also has some notable risks. Here are the most significant drawbacks to consider:
- High fees and factoring rates: A fee of 1% to 5% may not sound like much, but factoring costs can add up quickly—especially if customers take longer than you expect to pay. Factoring rates aren’t interest rates. When you compare actual APRs, factoring is typically much more expensive than other forms of financing.
- Loss of control over collections: In most cases, the factoring company takes responsibility for collecting payment from customers. That can be convenient, but it also means you can no longer control how those interactions go.
- Potential disapproval from customers: Some clients might not appreciate your use of invoice factoring. Often, they may prefer dealing with you directly or see it as an indication of financial strain, which can threaten the relationship.
Ultimately, invoice factoring is rarely a sustainable solution for liquidity issues. You’re often better off using it as a bridge for the occasional cash flow gap than as a long-term financing strategy.
When Is Invoice Factoring a Good Idea?
Invoice factoring is most useful when cash flow projections indicate you can’t afford to wait for your customers to pay you. Ideally, your customers also have strong credit histories and don’t mind a third party stepping in to handle collections.
This is most common in industries where factoring is already standard practice due to inherently slow payment cycles. For example, trucking, staffing and manufacturing companies incur significant costs to complete each project but may have to wait weeks or months before getting paid. Factoring helps bridge those gaps.
Factoring may not be as practical for businesses in other industries, especially those that are considered high-risk by factoring companies, like travel. These companies may face higher fees and lower advance amounts. Additionally, clients may not be as understanding of third-party collectors, which could damage your relationships.
How to Choose an Invoice Factoring Company
Invoice factoring companies can differ significantly in their terms and service quality. Here are some tips to help you evaluate providers before committing:
- Start with transparency: Look for factoring companies that are upfront about their terms and processes. If a provider avoids sharing information about their fees or discount rates, you don’t need to risk working with them.
- Compare terms and pricing: All else being equal, the best factoring company is the one with the most favorable terms, including the lowest costs and the highest advance amount. Dig into the details, including how the fees are structured.
- Consider their reputation: Read customer reviews to identify common pain points, such as hidden expenses, aggressive collection tactics or poor customer support. Look for concerns that clients raise consistently.
- Leverage free consultations: Many factoring companies offer free introductory calls before asking you to sign anything. Use them as an opportunity to ask more detailed questions about their terms, industry expertise, collections process and funding timelines.
Get Cash Flow Management Support
Invoice factoring can help you bridge cash flow gaps due to slow-paying customers, especially when traditional financing is unavailable or would be too slow. However, it may not be a practical way to manage liquidity issues over the long term.
For a more sustainable solution, work with one of Paro’s fractional CFOs, who specialize in capital management strategies. They can help you forecast more effectively, secure more favorable financing arrangements and reduce your reliance on short-term tactics.
