In this article, learn about:
What invoice factoring is and what businesses benefit most from using it
The difference between invoice factoring and invoice financing
The pros and cons of invoice factoring
Unpaid invoices can shut down operations completely for suppliers. This is especially true for small suppliers who are typically dependent on invoices being paid on time in order to process further orders. A successful supply chain requires money. But when that money gets tied up, it can create delays that ultimately result in lost revenue.
While this is, unfortunately, a common issue faced by suppliers, there are solutions. Suppliers do not have to accept this issue as “the way of the world.” Rather, suppliers have options, such as invoice factoring.
What Is Invoice Factoring?
Invoice factoring is a financing arrangement in which a supplier sells its outstanding invoices to a third-party company (called a factor) in exchange for immediate cash. Rather than waiting 30, 60, or even 90 days for a buyer or retailer to pay, suppliers can get most of the invoice value upfront, typically within 24–48 hours of submission.
Once a supplier has delivered their product and issued an invoice to their buyer, they would then sell the invoice to the factor. The factor advances a percentage of the invoice's face value — usually between 70% and 90% — and takes over responsibility for collecting payment from the buyer. Once the buyer pays the factor in full, the supplier receives the remaining balance, minus the factor's fee, which typically runs between 1% and 5% of the invoice value.
There are two main types of invoice factoring:
Recourse factoring: The supplier remains liable if the buyer fails to pay. The factor will still advance the cash, but if the buyer defaults, the supplier is responsible for repaying that advance.
Non-recourse factoring: The factor absorbs the risk if the buyer can't pay. These arrangements typically come with higher fees and stricter qualification requirements.
Invoice factoring converts the gap between issuing an invoice and receiving payment into a nonissue. That gap is one of the most common causes of cash flow strain for suppliers, particularly those working with large buyers with long payment terms as standard practice.
Choosing Between Invoice Factoring or Invoice Financing
While often used interchangeably, invoice financing and invoice factoring are two separate solutions for the same problem.
Where invoice factoring enlists a third party who purchases the delinquent invoice, invoice financing uses a third party to pay the invoice but requires later repayment by the supplier.
There are several differences between invoice financing and invoice factoring that suppliers should be aware of in order to determine which option works best for their business. Most notably, invoice financing and invoice factoring differ in the following ways:
Invoice ownership: With factoring, you sell the invoice outright. With financing, you borrow against the invoice as collateral. This is the foundational distinction everything else flows from.
Who collects: In factoring, the third-party factor takes over collections. In financing, you retain control of collections and pay the lender back yourself.
Cost structure: Factoring fees are typically a percentage of the invoice value. Financing works more like a traditional loan, accruing interest on the amount borrowed.
In general, suppliers who run smaller or newer businesses are more likely to benefit from invoice factoring, whereas larger and more established suppliers benefit more from invoice financing.
Invoice factoring does not require repayment and typically pays the supplier much sooner, making this solution highly beneficial to smaller or newer suppliers who are still ramping. Larger suppliers may find they want more control over the process, even if that means repayment, making invoice financing a better fit.
Related Reading: What Is Invoice Financing and How Does It Work?
Pros and Cons of Invoice Factoring
If a supplier is considering invoice factoring as a solution, it is important to consider the pros and cons to make the most informed decision possible.
Pros of Invoice Factoring
Faster access to cash: Invoice factoring provides suppliers with cash significantly sooner than other options, often within 24–48 hours.
No additional debt: Because a buyer is purchasing an asset, the supplier does not need to pay anything back, thus no new debt is incurred.
Scales with revenue: The more invoices are issued, the more cash is accessible to the supplier.
Collections handled: Collections are handled by the factor, giving suppliers space to focus on building their business rather than tracking down unpaid invoices.
Cons of Invoice Factoring
Higher costs: At face value, invoice factoring can be less expensive, but strain can occur if the buyer does not pay and the supplier must eat the cost of the advance as well as the original fees (which are variable based on the amount of the invoice).
Less visibility and control: Since the factor is the one handling collections, the supplier has less visibility into the actual process of the invoice being paid.
Recourse risk: If the buyer does not pay, the cost of repayment may fall back on the supplier, depending on the type of factoring.
How Suppliers Use Invoice Factoring
Invoice factoring is used across a wide range of industries and supplier types, but the situations that drive suppliers toward it tend to follow a few recognizable patterns.
Growing suppliers that are struggling to keep up with demand: Business is thriving, orders are increasing, but long payment terms from large buyers mean the cash to fulfill those orders simply isn't there yet. Factoring allows suppliers to convert outstanding receivables into working capital, accept larger contracts, and scale operations without taking on debt or waiting on buyers to pay.
Early-stage suppliers that are profitable on paper, but cash poor in practice. Traditional lenders want credit history and collateral that young businesses don't yet have. Factoring sidesteps this entirely, since approval is based on the buyer's credit rather than the supplier's.
Suppliers facing surprising growth: Unexpected growth can be just as destabilizing as a slow period, particularly for suppliers who need to hire, stock up on materials, or expand capacity quickly. When payment terms don't align with that urgency, factoring provides a bridge that turns existing receivables into the immediate cash needed to move fast.
Let SPS Commerce Help
Managing a growing business as a new supplier is overwhelming. A new contract with a big retailer is exciting, but it also comes with its own pitfalls. The SPS Commerce Supply Chain Performance Suite helps suppliers in every area of supply chain, freeing them to focus on making a profit.
