Invoice factoring: get most of each invoice paid upfront while the provider collects

Invoice factoring works by assigning your invoices to a factor, which advances most of their value and then takes over collecting them. The day-to-day mechanics matter, because the factor becomes the point of contact for your customers' payments.

1. The factor reviews your aged debtors and sets a credit limit for each approved customer.
2. You sign the agreement and assign the debts. Directors usually give a guarantee or an indemnity that invoices are genuine.
3. Customers receive a notice of assignment telling them to pay the factor.
4. You upload each invoice, often with proof of delivery or a signed timesheet, and draw an advance against it.
5. The factor sends statements, issues reminders and chases late payers.
6. When the customer pays, the factor reconciles the payment, deducts its fees and releases the balance to you.

Because the factor relies on your customers paying, clear proof of delivery from the start helps funding flow without delays.

The difference comes down to who carries the loss if an approved customer fails. With recourse factoring, your company carries it; with non-recourse factoring, the factor carries a defined part of it, for an extra charge and within strict conditions.

How recourse factoring works

On a recourse facility, each invoice has a recourse period, usually a set number of days after the invoice date or due date. If the customer has not paid by then, the factor will ask you to repay the advance, replace it with a new invoice, or deduct the amount from future funding. You still owe that money if the customer later goes out of business.

It is generally the lower-cost option and can work well when customers are established, reliable payers.

How non-recourse factoring works

On a non-recourse facility, the factor provides credit protection on approved customers up to the credit limit it has set for each one. If a covered customer enters a formal insolvency process, the factor absorbs the loss on covered invoices, after any excess or first-loss amount you agreed to bear.

The cover is usually narrower than people expect. It typically excludes:

• Invoices above a customer's approved credit limit
• Customers who pay late but are not insolvent
• Disputes about the quality, quantity or delivery of your goods or services
• Invoices raised in breach of the agreement, for example before work was delivered

Ask how a claim works, what evidence is needed and how long payment takes.

A factor's credit control service usually covers sales ledger administration, statements, payment reminders, chasing calls and allocating payments. In effect, you are buying in a credit control team, which is a large part of why factoring service fees are higher than those for invoice discounting.

Typical tasks include:

• Sending customer statements and reminder letters at agreed points
• Chasing overdue invoices and allocating payments
• Online reporting on what is owed and available to draw
• On many facilities, checking new customers before you agree credit terms with them

This service shapes your customer relationships, so ask: who will speak to my customers, how often and in what tone? Can we agree a contact plan for key accounts? Can I see the reminder letters? For example, a cleaning contractor with dozens of clients on monthly terms might gain back management time, provided the directors are comfortable with the factor's approach.

Customers are told through a formal notice of assignment and updated payment details on your invoices. Many business customers already pay factored suppliers, so a clear, early explanation from you usually makes the change straightforward.

In practice, notification often looks like this:

1. Each customer receives a letter explaining that invoices have been assigned and giving the new bank details.
2. Your invoices carry a short statement saying who to pay, with the factor's account details.
3. During set-up, the factor may contact some customers to verify outstanding invoices.
4. From then on, statements and reminders come from the factor's credit control team.

A short call to key customers beforehand helps: explain that the facility supports growth, your service will not change and only payment details differ. Consistent messages from your team and the factor avoid payment delays.

Factoring costs usually combine a service fee for credit control and ledger management, a discount charge on funds drawn and, if you choose it, a charge for bad debt protection. Minimum fees, set-up costs and exit fees can also apply.

Factors price the service fee on how much work your ledger creates: many small invoices usually cost more to manage than a few large ones. Late payers also push up the discount charge.

Illustrative example only: actual costs depend on the lender and your circumstances.

A recruitment agency invoices a client £20,000 for temporary staff on 45-day terms. Its non-recourse factoring facility advances 85%, and charges a 2% service fee on invoice value, a discount charge of 0.8% per month on the advance, and 0.5% of invoice value for bad debt protection.

• Advance: £17,000 (85% of £20,000)
• Service fee: £400 (2% of £20,000)
• Discount charge for 1.5 months: £204 (0.8% × 1.5 × £17,000)
• Bad debt protection: £100 (0.5% of £20,000)
• Total cost: £704
• Balance released when the client pays: £2,296 (£20,000 minus £17,000 minus £704)

Try your own figures in our invoice finance calculator.

A factor sets your funding by deciding which customers it will approve, how much credit it will allow each one, and what percentage of each approved invoice it will advance. Your available funds on any day result from all three.

Advance rates vary by lender and sector. A factor may lower the advance where invoices are often disputed, one customer dominates the ledger or proof of delivery is weak. A record of clean invoices can help you negotiate better terms over time.

If you win a large new client, ask the factor to review its credit limit before you start trading, so invoices above the limit are not left unfunded.

The key risks are being tied into a long contract, paying minimum fees if turnover falls, and personal liability through guarantees or indemnities. Read these terms closely:

• Whole turnover clause: many agreements require all invoices to all customers to go through the facility, not just the ones you choose.
• Minimum term, notice and termination fees: how long you are committed, how much notice you must give and what it costs to leave early.
• Recourse terms: the exact number of days before an unpaid invoice comes back to you.
• Security and guarantees: any debenture, personal guarantee or indemnity, and what each one covers. Our guide on what a personal guarantee is explains the basics.
• Extension fees: charges on invoices unpaid beyond a set period.
• Collect-out terms: how your ledger is handled if the facility ends.

Factoring is often the better fit when you want both funding and a collections service. Otherwise, compare:

• Invoice discounting: usually cheaper and can be confidential, but you keep doing credit control and lenders expect a larger, established business.
• Invoice finance overview: explains selective invoice finance and how to choose between all the invoice-based options.
• Unsecured business loans: a fixed sum repaid over a set term. These can suit a one-off need where you would rather not involve a finance provider in your sales ledger.

Our guide to factoring vs invoice discounting compares the two main ledger-based options in more depth.

Often more readily than with many other types of finance, because the factor relies heavily on your customers paying and runs collections itself. Even so, each lender sets its own criteria and makes its own decision.

Factors focus mainly on the quality of your customers and invoices. A company with a short trading history, past adverse credit or thin profits may still be considered if it sells to creditworthy businesses, has clear terms of trade and can prove work was delivered. Minimum trading periods vary by lender, from a few months to two or three years.

Invoice factoring for limited companies, LLPs and partnerships of four or more partners is generally unregulated. Consumer Credit Act protections generally do not apply, so your rights and obligations come mainly from the factoring agreement itself.

Welcome Finance is not authorised or regulated by the FCA and arranges unregulated business finance only. Read the agreement and fee schedule in full, and consider independent legal or accounting advice before signing. Our guide on regulated vs unregulated business finance explains what this means for your company.

We help you find factors on our panel whose service suits your customers. Your dedicated relationship manager, a real person, stays with you by phone, email and chat from first enquiry until the lender pays out.

• We check your eligibility in about 60 seconds without affecting your credit score.
• We help you compare recourse terms, customer credit limits, service fees, minimum terms and notice periods across offers.
• We help you plan how to tell your customers.
• Lenders run their own credit checks only after you decide to apply.

There is no fee to you. We are paid a commission by the lender when your finance completes. You can ask how much we will receive, and it can differ between lenders.

Can I choose which customers the factor contacts?

On a whole-ledger facility, the factor usually collects from every customer. Some agree to exclude certain accounts or adapt their approach for key clients.

Does the factor chase customers in its own name or mine?

It varies. Some chase in their own name, while others send reminders that appear to come from your company. Check before signing.

What is a notice of assignment?

It is a formal notice telling your customer that the debt has been assigned to the factor and that payment must now go to the factor. Once a customer has received it, paying you instead may not clear what they owe.

What happens if a customer pays me by mistake?

You will usually need to pass the payment to the factor promptly, often within a set number of days. Keeping the money is normally a serious breach of the agreement.

Can I end a factoring agreement early?

Usually, but you may pay a termination fee and must repay money drawn. Check the minimum term and notice period.

Will the factor credit check my new customers?

Many factors check new customers before setting a credit limit, which can help you decide whether to offer credit terms at all.

How does factoring work with weekly payroll?

Recruitment agencies, for example, often upload client-approved timesheets weekly and draw funding to pay workers before clients settle.

Is recourse factoring risky if I rely on one large customer?

It can be. If a large customer fails on a recourse facility, you would need to repay the advances against its invoices. That concentration of risk is one reason companies with a major customer often look at non-recourse cover.