Invoice factoring: cash from your invoices, with collections handled for you

The difference is who carries the loss if a customer never pays: with recourse factoring you do, and with non-recourse factoring the funder or its credit insurer does, within agreed limits. This choice affects both the cost and the protection you get.

Recourse factoring

Under a recourse facility, if an invoice is not paid within an agreed period (often 90 to 120 days from the invoice date, depending on the lender), the factor can ask you to repay the prepayment or replace it with a newer invoice. Recourse factoring is the more common and usually the cheaper structure, because the funder is not taking the credit risk on your customers.

Non-recourse factoring and bad-debt protection

Non-recourse factoring includes bad-debt protection, normally through credit insurance arranged by or through the funder. If a customer becomes insolvent, the insured portion of the debt is covered up to a credit limit set for that customer. It is not blanket protection. Cover usually applies only to approved customers, within each customer's limit, and often only to insolvency rather than to disputes over the quality of your work. There is normally a first-loss share that you bear. Read the policy terms as closely as the factoring agreement itself.

Some businesses buy credit insurance separately and assign it to the funder, which can suit firms that already have a policy in place. Either way, bad-debt protection is a cost, so it makes most sense where a single customer failure would do serious damage.

Invoice factoring suits younger and smaller B2B businesses that sell on credit terms, are growing faster than their cash allows and do not have an in-house credit control team. Lenders often accept businesses with a short trading history, because the funding is assessed largely on the quality of the invoices and the customers who owe them.

Typical users include:

• Recruitment agencies paying temporary workers weekly while clients pay monthly. Specialist recruitment finance often combines factoring with payroll support.
• Manufacturers, wholesalers and distributors supplying larger trade customers on 30 to 90 day terms.
• Logistics, haulage, security, cleaning and facilities firms with regular, repeatable invoices to commercial clients.
• Business services companies whose owners would rather spend time selling than chasing payment.

Factoring is usually a poor fit where:

• You sell mainly to consumers rather than businesses. Consumer debts are rarely funded.
• Invoices depend on stage payments, applications for payment or retentions. Construction receivables are specialist, covered on our construction invoice finance page.
• You strongly prefer customers not to know a funder is involved, or you have robust credit control already. Confidential options are explained under confidential invoice finance.
• You only need occasional funding on a handful of invoices, rather than a facility across the whole ledger.

A new factoring facility typically takes one to three weeks from application to first drawdown, though it depends on the lender and the case. The timetable moves with how quickly you supply the documents above, whether the lender needs to verify invoices with your customers before going live, and whether an existing lender must release its charge over your debts. Once the facility is running, funds against newly submitted invoices often arrive within a working day, subject to the funder's cut-off times and any same-day payment fee.

Moving from one factor to another adds time, because the outgoing funder's ledger has to be settled or bought out and its notice period served.

Factoring is secured mainly on the invoices themselves, which the funder buys or takes an assignment over, but most lenders also take further security. A typical package includes a debenture over the company, giving the funder a charge over its book debts and other assets. Our guide to debentures and fixed and floating charges explains how these rank.

Directors are commonly asked for a warranty or indemnity, which makes them personally liable if invoices turn out to be invalid, for example because the work was never done or the invoice was raised twice. Some lenders also ask for a personal guarantee. Read our guide to personal guarantees before signing, and ask what the funder will accept in place of an unlimited guarantee.

Factoring is usually priced with two main charges, a service fee and a discount charge, plus a number of smaller fees that vary by lender. Understanding each one matters more than comparing a single headline number.

• Service fee. A percentage of your invoiced turnover. With factoring it covers the funder's administration and the cost of running your credit control, which is why factoring service fees tend to be higher than those on invoice discounting.
• Discount charge. Interest on the money you actually draw, usually set as a margin over the Bank of England base rate and charged daily on the outstanding balance.
• Bad-debt protection. An extra premium or fee on non-recourse facilities.
• Other charges. These can include a minimum monthly or annual fee, same-day payment fees, set-up or survey fees, periodic audit fees, charges for disapproved or refactored invoices, and costs if you leave before the end of the minimum term.

The minimum fee catches many businesses out. If your turnover falls below what the facility was priced on, you may still pay the minimum. Ask any lender to show the total cost on your realistic turnover, not just the headline service fee.

Minimum terms and notice periods

Whole-turnover factoring agreements usually run for a minimum term, often 12 months, followed by a notice period, often three months. Leaving early can mean termination fees, and when you do exit you will need to repay the outstanding prepayments, either from collected debts, from a new funder or from your own cash. Check the notice period before you sign, not when you want to move.

Spot factoring funds a single invoice or a small batch of chosen invoices, without committing your whole sales ledger. It suits occasional cash needs, such as a large order or a seasonal peak, but the cost per invoice is usually higher and some funders only take invoices to customers with strong credit. We cover it in detail on our selective invoice finance page.

If factoring does not fit, the main alternatives are other forms of invoice finance, revolving facilities and term borrowing. Each solves a slightly different problem.

• Invoice discounting for established businesses that want to keep collections in-house.
• Selective invoice finance for funding chosen invoices without a whole-turnover contract.
• A revolving credit facility for flexible drawing that is not tied to individual invoices.
• Working capital loans for a lump sum repaid over a fixed term.
• Export invoice finance where a large share of your customers are overseas.

If the real issue is a few slow payers rather than a structural cash gap, our guide to chasing late payments may help first.