What is Invoice Factoring?

Invoice factoring is a form of financing where a business sells its outstanding invoices to a factoring company (known as a factor) in exchange for an immediate cash advance, typically 70% to 90% of the invoice value. The factor then collects payment directly from your customers and pays you the remaining balance, minus their fees.

This type of finance is particularly useful for businesses that sell on credit terms and need to bridge the gap between issuing invoices and receiving payment. It sits alongside other forms of debt financing as a way to access working capital without taking on a traditional business loan.

How Invoice Factoring Works

The process typically follows these steps:

1. You deliver goods or services to your customer and issue an invoice with standard payment terms (e.g. 30, 60, or 90 days)
2. You submit the invoice to the factoring company
3. The factor advances cash — usually 70% to 90% of the invoice value — within 24 to 48 hours
4. The factor collects payment directly from your customer when the invoice falls due
5. You receive the balance minus the factor’s fees once the customer pays

The factor takes on the credit control function, chasing payment from your customers and managing the sales ledger on your behalf.

Types of Invoice Factoring

Disclosed (Notification) Factoring

Your customers are informed that their invoices have been assigned to a factoring company. The factor handles credit control and collection directly. This is the most common form in the UK.

Confidential Factoring

Your customers are not told about the arrangement. You continue to manage credit control, and the factor operates in the background. This preserves your customer relationships but is usually more expensive.

Recourse Factoring

If your customer does not pay the invoice, you must buy it back from the factor. This is the most common and cheapest form because the factor carries less risk.

Non-Recourse Factoring

The factor absorbs the bad debt risk. If your customer fails to pay (due to insolvency, for example), the factor takes the loss. This is more expensive but provides credit protection.

Invoice Factoring vs Invoice Discounting

These two terms are often confused, but there is an important difference:

Invoice discounting is essentially a loan secured against your invoices, while factoring includes the credit management service.

Costs

Invoice factoring fees have two main components:

Additional charges may include:

• Minimum volume fees — If your invoice volume falls below a threshold
• Credit check fees — For assessing new customers
• Transfer fees — If you switch providers
• CHAPS or faster payment fees — For expedited fund transfers

For a business turning over £500,000 with 45-day payment terms, annual factoring costs might be in the range of £7,500 to £25,000, depending on the provider and risk profile.

Benefits of Invoice Factoring

• Improved cash flow — Access up to 90% of your invoice value within 24 hours, rather than waiting 30 to 90 days
• Outsourced credit control — The factor chases payments, saving you time and staff costs
• Scalable funding — As your sales grow, so does your available funding, unlike a fixed overdraft limit
• No additional debt — Factoring is the sale of an asset (your invoice), not a loan, so it does not add to your borrowings in the same way
• Bad debt protection — With non-recourse factoring, you are protected against customer insolvency

Drawbacks

• Cost — More expensive than a simple overdraft or loan for the same amount of capital
• Customer perception — Disclosed factoring may signal financial difficulty to customers
• Contract terms — Many factors require minimum terms (often 12 to 24 months) and minimum volumes
• Selectivity — The factor may refuse to advance against invoices to customers they consider high-risk
• Loss of control — With disclosed factoring, the factor manages your customer relationships around payment

Who Uses Invoice Factoring?

Invoice factoring is particularly common in industries where long payment terms are standard:

• Recruitment agencies — Paying workers weekly while clients pay monthly or quarterly
• Transport and logistics — High operating costs with delayed customer payments
• Manufacturing — Large material costs incurred well before customer payment
• Construction — Long project timelines with staged billing
• Wholesale and distribution — High turnover with tight margins

Accounting Treatment

When you factor an invoice, the accounting treatment depends on whether the arrangement transfers the risks and rewards of ownership:

• Recourse factoring — The invoice typically remains on your balance sheet as a receivable, with the advance recorded as a liability
• Non-recourse factoring — The invoice is derecognised (removed from the balance sheet), and the transaction is treated as a sale of the receivable

Factoring fees are an allowable expense for Corporation Tax purposes, and proper accounting for factoring arrangements is essential for accurate financial reporting.

How to Choose a Factor

When selecting a factoring provider, consider:

• Advance rate — What percentage of the invoice value will you receive upfront?
• Fee structure — Compare the total cost, not just individual fees
• Contract flexibility — Look for short notice periods and no minimum volume penalties
• Industry expertise — Some factors specialise in particular sectors
• Funding limits — Ensure the facility can grow with your business
• Reputation — Check reviews and ask for references from similar businesses

The Asset Based Finance Association (ABFA) is the UK trade body for invoice finance providers and maintains a list of members.

Alternatives to Invoice Factoring

• Overdraft — Simpler short-term cash flow facility
• Business loan — Fixed-term borrowing for planned needs
• Asset finance — If you need to fund equipment rather than working capital
• Crowdfunding — Raise funds from multiple backers for specific projects