Invoice Factoring

Invoice factoring is the sale of a business's unpaid invoices to a third party, called a factor. Instead of waiting weeks for customers to pay, the business gets most of the cash right away, and the factor collects later.

A factoring deal has three parts. The advance is the share of the invoice paid up front. The reserve is the part held back to cover short payments and disputes. The fee is what the factor earns, often a percentage of the invoice that grows the longer it stays unpaid. Say a trucking company sells a $10,000 invoice with a hypothetical 85 percent advance. It gets $8,500 today. When the shipper pays the full $10,000 a month later, the factor keeps a $300 fee and releases the remaining $1,200 of reserve.

There are two main forms. In recourse factoring, the business must buy back invoices its customers fail to pay. In non-recourse factoring, the factor absorbs the loss if a customer can't pay for credit reasons, and charges more for that protection.

Why it matters for lenders

For a factor, the asset is only as good as the invoice behind it. Invoices can be fake, already paid, or sold to two funders at once. Factors manage this by verifying invoices with the customer, sending a notice of assignment that tells the customer to pay the factor directly, and filing a UCC-1 financing statement to put other creditors on notice. They also watch concentration, since one slow-paying customer can tie up a large share of a client's funding.

Factoring is a close cousin of asset-based lending (ABL). Both turn receivables into cash, but factoring buys the invoices while ABL lends against them. In the US, some states, including California and New York, now require cost disclosures on certain factoring deals under their commercial financing disclosure laws, so pricing has a compliance side too.

How it works in practice

A factor serving trucking companies may take in hundreds of invoice batches a day. For each batch, an account manager checks that the client is in good standing, that each customer has credit room left under its limit, and that the rate confirmation and proof of delivery are attached. Staff verify a sample of invoices, fund the advance by ACH (the US electronic bank transfer network), and post the purchase. When payments arrive, the team matches each one to its invoice, takes the fee and releases the reserve.

In spreadsheets, duplicate invoices slip through, customer limits go stale, and reserve balances drift from the bank. One record per client, with invoices, verifications and payments tied together, makes daily funding faster and easier to audit.