Selling Your Invoices Is Borrowing Against Customers Who Have Not Paid Yet
Factoring converts receivables into cash immediately at a discount. It is expensive, it is available to companies that cannot borrow otherwise, and the reason is that the lender is assessing your customers rather than you.
The Problem It Solves
A company delivers goods and issues an invoice payable in sixty days. It has earned the revenue and it has no cash, while wages, suppliers, and the next production run all require payment sooner.
That gap between delivering and being paid is a working capital requirement, and for a growing company it widens as sales grow. Growth consumes cash before it produces it.
A fast growing company can be profitable and run out of money, because every new order requires cash months before it delivers any.
How Factoring Works
The company sells its receivables to a factor, which advances a percentage immediately, commonly seventy to ninety percent, and pays the balance less its fee once the customer settles.
The critical distinction is recourse. Under a recourse arrangement, if the customer fails to pay, the company must repay the advance. Under non recourse, the factor absorbs that loss, which costs more and transfers genuine credit risk.
Why the Credit Decision Is Different
| Bank loan | Factoring | |
|---|---|---|
| Credit assessed on | The borrower | The borrower customers |
| Available to young firms | Rarely | Yes, if customers are strong |
| Scales with | Balance sheet | Sales |
| Cost | Lower | Higher |
This is the feature that matters. A small company with no track record supplying large creditworthy customers can access funding based on those customers quality rather than its own. A bank would decline the same company.
It also scales naturally. As sales grow, receivables grow, and available funding grows with them, which suits exactly the situation that creates the problem.
The Cost and Why It Is High
Effective annualised costs are well above bank lending. Part of that reflects genuine expense, since the factor administers collections and assesses many small customer credits. Part reflects that the users often have no cheaper alternative.
Quoted rates are usually expressed per period rather than annually, which makes them look smaller than they are. A discount of two percent for thirty days is roughly twenty four percent annualised, and comparisons should be made on that basis.
The Signalling Problem
Notified factoring means customers are told to pay the factor directly, which reveals the arrangement. Historically this carried a stigma, implying the supplier could not obtain normal financing.
That perception has weakened considerably as receivables finance became mainstream, and confidential arrangements exist where the company continues collecting. The stigma matters most for small suppliers dealing with customers who might read it as distress.
Supply Chain Finance, the Inverted Version
A related structure runs from the buyer side. A large creditworthy buyer arranges for its suppliers to be paid early by a financier, at a rate based on the buyer credit rather than the supplier.
That is genuinely cheaper for suppliers and it deserves scrutiny, because it can allow a buyer to extend its own payment terms substantially while presenting the arrangement as supplier support. Where such programmes are large and undisclosed, they function as debt without appearing as debt, and that has featured in several corporate failures.
The Bottom Line
Factoring turns receivables into immediate cash by shifting the credit assessment onto the customers who owe the money, which makes it available to companies banks decline and expensive relative to bank debt. It scales with sales, which fits the growth problem it solves, and its buyer led variant deserves attention because it can conceal leverage.