A factor payment is money a business receives when it sells its unpaid invoices to a third party at a discount

When a business has customers who owe them money but needs cash now instead of waiting 30, 60, or 90 days for payment, it can sell those invoices to a factor — a company that buys receivables. The factor pays the business when ready, but less than the full invoice amount. The difference between what the business receives and what the invoice is worth is the factor's fee for taking on the risk that the customer might not pay.

For example: a business has a $10,000 invoice due in 60 days. A factor might pay $9,200 today. The business gets cash when ready and avoids waiting. The factor collects the full $10,000 from the customer later and keeps the $800 difference as profit and fee. This transaction is called factoring, and the money the business receives is the factor payment.

Factor payments are common in industries where customers take a long time to pay — construction, staffing, transportation, and wholesale distribution. They are not loans. The business is not borrowing money; it is selling an asset (the right to collect the invoice) for less than face value.

Key Takeaways

  • A factor payment is the cash a business receives when it sells unpaid invoices to a factoring company for when ready money.
  • The factor pays less than the full invoice amount; the difference is the factoring fee, which typically ranges from 1% to 5% of the invoice value depending on industry and customer risk.
  • Factoring is not a loan and does not create debt on the business's balance sheet, though it does reduce the cash the business ultimately receives from its customers.
  • The factoring company takes on the risk that the customer will not pay the invoice, and collects directly from the customer after the factor payment is made.

How the factor payment process works

The business submits one or more unpaid invoices to the factoring company. The factor reviews the invoices and the creditworthiness of the customers who owe the money. If approved, the factor offers a rate — the percentage of the invoice value it will discount. Rates vary widely depending on how risky the customer is, how long the invoice is outstanding, and what industry the business operates in.

Once the business accepts the rate, the factor transfers the payment, usually within 24 to 48 hours. The business no longer owns the right to collect that invoice. The factor now owns it and will contact the customer directly to collect payment. When the customer pays, the money goes to the factor, not back to the original business.

Some factoring arrangements are recourse, meaning if the customer does not pay, the business must buy the invoice back or refund the factor payment. Other arrangements are non-recourse, meaning the factor absorbs the loss if the customer defaults. Non-recourse factoring costs more because the factor bears all the collection risk.

Who uses factor payments and why

Businesses use factoring when they have a cash flow problem but healthy invoices. A construction company might complete a job in week one but not receive payment until week eight. Rather than wait or borrow money at interest, it can factor the invoice and pay its workers and suppliers on time. A staffing agency might place workers at a client site but not get paid for 45 days; factoring lets it pay the workers weekly.

Factoring is also used by businesses that are growing fast. A growing company might have more work than it can afford to fund out of pocket. Factoring lets it take on more customers without running out of cash waiting for invoices to be paid. It is also common among businesses with poor credit or no credit history, since factoring does not require a credit check the way a bank loan does.

Businesses that cannot use factoring include those with no invoices (service businesses that collect payment when ready), those whose customers are individuals rather than other businesses, and those whose invoices are disputed or uncertain. Factoring only works when the invoice is legitimate, undisputed, and the customer is creditworthy enough that the factor believes it will be paid.

Factor payment fees and what they cost

The cost of a factor payment is built into the discount rate. A factor might offer 92% of invoice value, meaning a 8% fee. Another might offer 95%, meaning a 5% fee. The rate depends on several things: how creditworthy the customer is, how long the invoice has been outstanding, what industry the business is in, and whether the factoring is recourse or non-recourse.

A business with invoices from Fortune 500 companies might get a 2% to 3% rate because those customers almost always pay. A business with invoices from small or new customers might pay 4% to 8% or higher. If an invoice is already 60 days old, the rate will be higher than for a fresh 30-day invoice. Construction and staffing typically have higher rates than manufacturing or distribution because the payment risk is higher.

The fee is a one-time cost per invoice. Once the factor payment is made, there are no additional charges unless the business factors more invoices later. This is different from a loan, where interest accrues over time. A business should compare the cost of factoring to the cost of a bank line of credit or waiting for customers to pay, since in some cases borrowing money is cheaper than factoring.

Factor payments versus loans and other financing

A factor payment is not a loan. A loan is a debt the business must repay with interest, and it appears on the balance sheet as a liability. A factor payment is a sale of an asset, and it does not create debt. From an accounting standpoint, factoring is cleaner because it does not increase the business's debt-to-income ratio, which can affect its ability to borrow money later.

However, factoring costs more than a bank loan in most cases. A business might borrow $10,000 at 8% annual interest, paying $800 per year. The same business might factor a $10,000 invoice at 5%, paying $500 one time. But if the business factors invoices every month, the costs add up quickly. A business should calculate the total annual cost of factoring versus the cost of a line of credit before committing to either.

Other alternatives include supply chain financing (where a supplier or vendor advances money), invoice discounting (similar to factoring but the business still collects the invoice), and straightforward waiting for customers to pay. The right choice depends on how urgent the cash need is, how much it costs, and what the business can may have access to for.

When factor payments create problems

Factoring can damage a business's relationship with its customers. When a factor takes over collection, the customer now deals with a third party instead of the original business. Some customers resent this and may take their business elsewhere. Factoring also signals to customers that the business has cash flow problems, which can hurt its reputation.

Recourse factoring creates risk for the business. If a customer disputes an invoice or does not pay, the business must refund the factor payment or buy the invoice back. This can leave the business worse off than if it had straightforward waited for payment. A business should understand the recourse terms before signing a factoring agreement.

Factoring can also become expensive if the business relies on it heavily. A business that factors most of its invoices every month is paying a significant percentage of its revenue in fees. Over time, this can make the business less profitable and harder to grow. Factoring works best as a temporary solution for cash flow gaps, not as a permanent financing strategy.

Frequently Asked Questions

Is a factor payment the same as a loan?

No. A factor payment is the sale of an invoice for less than its face value. A loan is borrowed money that must be repaid with interest. Factoring does not create debt on the business's balance sheet, while a loan does. However, factoring costs money upfront, while a loan spreads the cost over time.

Can a business factor invoices from individuals or only from other businesses?

Factoring works almost exclusively with invoices from other businesses. Factors will not buy invoices from individual consumers because the collection risk is too high and individuals are harder to pursue legally for non-payment. Factoring is a business-to-business tool.

What happens if a customer does not pay an invoice that has been factored?

If the factoring is non-recourse, the factor absorbs the loss and the business keeps the factor payment. If it is recourse, the business must refund the factor payment or buy the invoice back. The business should always know which type it has agreed to before factoring an invoice.

How long does it take to receive a factor payment?

Most factors transfer money within 24 to 48 hours of approval. Some offer same-day funding for an additional fee. The approval process itself usually takes one to three business days, depending on how quickly the factor can verify the invoice and assess the customer's creditworthiness.

Can a business factor invoices that are already past due?

Yes, but the factor will pay less. An invoice that is already 60 or 90 days old is riskier because the customer has already missed the original due date. The factor will offer a lower percentage of the invoice value to account for that risk. Some factors will not buy very old invoices at all.