What Invoice Factoring Actually Is
Invoice factoring lets your company sell its unpaid business-to-business invoices to a finance provider, the factor, in exchange for an immediate cash advance. Instead of waiting 30, 60 or 90 days for a customer to pay, your business receives most of the invoice value within 24 hours. When the customer eventually settles, the factor releases the balance to you, less its charges.
The critical feature that separates factoring from its sibling product, invoice discounting, is that the factor takes over your credit control. The factor chases your customers, applies the payment when it lands, and manages the sales ledger on your behalf. You outsource the collections function along with the funding. For a company running fast ahead of slow-paying customers, that combination of instant cash and offloaded admin is the whole appeal.
Factoring funds the debtor book, not the balance sheet as a whole. That means a company can often factor even when it would struggle to secure a conventional term loan, because the lender is underwriting your customers' ability to pay rather than your own trading history. For the full picture of how factoring sits alongside discounting and selective finance, see our complete guide to invoice finance.
Disclosed by Design: Your Customers Are Notified
Factoring is a disclosed facility. When you set it up, your customers are formally told that a factor now handles collection of their account. Your invoices carry an assignment notice directing payment to the factor's trust account, and the factor's collections team contacts your customers directly to chase overdue amounts.
This visibility cuts both ways. On the positive side, a professional collections team often gets invoices paid faster than an overstretched in-house finance function, and your directors stop spending Friday afternoons chasing debtors. On the other side, some companies dislike a third party contacting their customers, worried it signals cash-flow strain. If confidentiality matters more than outsourced collections, confidential invoice discounting keeps the arrangement private and leaves collections with you.
How the Money Works: Advance, Service Fee and Discount Margin
Three numbers determine what factoring costs your company.
- The advance rate. Usually 80% to 90% of the invoice value, paid within 24 hours. The rest is held back until your customer pays.
- The service fee. Typically 0.5% to 3% of gross turnover run through the facility. This pays for credit control, collections and ledger administration. It is the charge that varies most by turnover, sector and debtor spread.
- The discount margin. Usually 2% to 4% over base rate, charged like interest on the funds you actually draw, for as long as they are drawn.
On top of the headline two, factors commonly add arrangement fees, minimum monthly fees, audit or survey fees, and charges for same-day CHAPS payments. When you compare quotes, the service fee percentage and the minimum-fee floor are where the real differences hide.
Worked example: financing a single invoice
Suppose your company raises a £30,000 invoice on 45-day terms and factors it.
- Advance rate 85%: you receive £25,500 the next day.
- Service fee 1.8% of the £30,000 invoice: £540.
- Discount margin, say 8% per year all-in on the £25,500 drawn for 45 days: roughly £25,500 × 8% × 45 ÷ 365 = £251.
Total cost to finance that one invoice for 45 days is about £791, and when the customer pays £30,000 the factor releases the retained £4,500 less those charges. On a single invoice that is an effective annualised cost well into double digits, which is why factoring is a cash-flow tool, not cheap long-term debt. The trade-off is speed and the collections service, not the lowest possible interest rate.
Recourse vs Non-Recourse: Who Carries the Bad Debt
Every factoring agreement is either recourse or non-recourse, and the difference decides who loses if a customer never pays.
Under recourse factoring, if an invoice goes unpaid past an agreed recourse period, commonly 90 to 120 days, the factor recharges the advance back to your company. You keep the bad-debt risk and pursue or write off the debt yourself. Recourse is cheaper because the factor is not insuring you against loss.
Under non-recourse factoring, the factor absorbs approved bad debts if a customer becomes insolvent, up to a credit limit it sets for each debtor. This protects your cash flow but costs more, and the protection only applies within those per-customer limits. Crucially, it usually excludes disputes: if a customer withholds payment because of a quality or delivery argument, that is your commercial problem, not a covered bad debt. Read the schedule of credit limits carefully, because an invoice above the limit for that customer is effectively on recourse anyway.
Outsourced Credit Control: The Real Pro and Con
Handing collections to the factor is the defining benefit and the defining drawback of factoring in one decision.
The upside is genuine. A dedicated collections team, calling on your behalf with the leverage of a funder, typically pulls in payments faster and more consistently than a small finance department juggling other work. For companies with thin or non-existent credit-control resource, that is often worth more than the funding itself. Recruitment agencies and commercial cleaners running weekly payroll against slow customer terms lean on this hard, as we cover in our guide to invoice finance for recruitment agencies.
The downside is control. A factor chasing your key customers may be more aggressive than you would be with a relationship you value. You lose some ownership of the customer conversation, and if the factor mishandles a sensitive account it can strain a commercial relationship you spent years building. Companies that guard those relationships closely, and have the systems to collect well themselves, often prefer discounting for exactly this reason.
The Traps Buyers Miss: Termination Notice and Trailing Commission
The day-one advance rate is what gets sold to you. The exit terms are what cost you, and they are buried in the contract. Two clauses catch companies out repeatedly.
Termination notice periods. Most factoring agreements require written notice to leave, often 30, 60 or 90 days, and frequently sit on a minimum term of 12 months. During the notice period the facility keeps running and the factor keeps charging. If you want to move to a cheaper funder, you cannot simply walk.
Trailing commission. Even after you serve notice, some factors continue charging the service fee on invoices they are still collecting during a run-off period. So the cost trails past your last new invoice. Layer that on top of a minimum monthly fee and the true cost of the arrangement stretches well beyond what the sales sheet implied.
Worked example: the cost of leaving
Take the same company factoring roughly £250,000 of invoices at any one time, on a 90-day notice period. Serve notice today and the ledger keeps turning for three months. If the service fee runs at about 1.8% on the turnover collected during that run-off, and a minimum monthly fee applies, the exit can quietly cost several thousand pounds on top of the discount margin on funds still drawn. None of that appears in the advance rate. This is why we tell company directors to model the exit cost before signing, not the headline advance.
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Factoring vs Invoice Discounting: Which One Fits
Factoring and discounting both advance cash against unpaid B2B invoices. The choice comes down to two questions: who runs collections, and do your customers need to know.
| Feature | Factoring | Invoice discounting |
|---|---|---|
| Customers notified? | Yes, disclosed | No, confidential |
| Who runs credit control? | The factor | Your company |
| Typical cost | Higher (collections included) | Lower (you collect) |
| Best for | Thin or stretched finance teams | Larger companies with strong systems |
| Typical qualifying scale | Lower turnover accepted | Higher turnover and covenant |
In short, factoring buys you a collections service alongside the cash, which is why smaller companies and those without a credit controller gravitate to it. Discounting is cheaper and confidential but assumes you can run your own ledger to a lender's satisfaction. Our invoice discounting guide sets out the turnover and systems thresholds factors expect before they will let you keep collections in-house.
Who Invoice Factoring Suits
Factoring earns its cost when a company invoices other businesses on credit terms, has a reasonable spread of creditworthy customers, and lacks the internal resource to chase payment efficiently. The classic profile is a company where the wage run or supplier payments fall due weeks before customers pay: recruitment desks, commercial cleaning and security firms, hauliers, wholesalers and manufacturers with long order-to-cash cycles.
It is the wrong tool for card-led or consumer-facing businesses. A shop, a restaurant or a B2C ecommerce seller has no trade-debtor book to factor, and would be better served by a merchant cash advance or a revolving credit facility. Contracts heavy with retentions, contra-charges or pay-when-paid terms, such as much of construction, often need a specialist facility rather than vanilla factoring.
Company Borrowers Only: How We Fit In
Company borrowers only. The finance introductions on this page are for UK limited companies and limited liability partnerships borrowing for business purposes. We introduce your company to a panel of commercial-finance brokers; we are not a lender and do not give regulated credit advice. If you are a sole trader, an individual, or borrowing for personal or household purposes, this service is not for you and you should speak to an FCA-authorised consumer-credit firm.
Introducing a body corporate to a finance provider is not credit broking under Article 36A of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, which is why this cluster is fenced to companies. Separately from the finance itself, our own accountants at Holloway Davies can advise on how factoring costs are treated for tax. For a limited company, service fees and discount charges are normally allowable revenue deductions against trading profit, reducing your corporation-tax bill at your marginal rate (19% up to £50,000 of profit, 25% above £250,000, with an effective 26.5% marginal band between). VAT treatment varies by charge type, and the VAT registration threshold sits at £90,000, covered in our note on the VAT registration threshold. Speak to us for the tax and structuring angle once the finance is in place.
How to Apply
A factor assesses three things: the credit strength of your customers, the quality and documentation of your sales ledger, and any concentration risk where one or two customers dominate your book. Clean invoices with clear proof of delivery, a well-spread debtor list and up-to-date management accounts all speed approval and improve the advance rate you are offered.
Setting up a facility usually takes one to three weeks, covering the credit assessment, a ledger survey and the legal documentation. Because factors vary widely on service fee, minimum term and exit terms, comparing several is worth the effort, and a broker panel does that matching in one step. For the broader menu of company funding options, from term loans to asset finance, start with our business loans guide.
Authoritative Sources
For independent guidance on invoice finance and company borrowing, see:
- UK Finance, for invoice finance and asset-based lending statistics and standards.
- British Business Bank, on how invoice finance works for smaller businesses.
- gov.uk business finance and support, for the range of funding options.
- The Regulated Activities Order 2001 (SI 2001/544), including Article 36A on credit broking and the body-corporate position.
- HMRC Business Income Manual (BIM45301), on the deductibility of finance and interest costs.