What is invoice factoring?

Invoice factoring is a financing arrangement in which a business sells its accounts receivable to a third party (a factor) at a discount, receiving immediate cash rather than waiting for client payment. For professional service firms with long payment cycles, factoring can accelerate cash flow but at significant cost (typically 2 to 5% of invoice value). Factoring makes sense only when the cost of waiting exceeds the factoring fee or when cash constraints are acute.

Key characteristics

• Sells receivables to a third party for immediate cash

• Typically advances 80 to 90% of the invoice value immediately

• Remaining amount paid when the client pays minus fees

• Fees typically range from 2 to 5% of invoice value

• Maybe recourse (you guarantee payment) or non-recourse

• Can improve cash flow, but at a high cost

Why it matters for professional service firms

Invoice factoring solves cash timing problems, but at a material cost. A firm factoring $100K monthly at 3% fee loses $36K annually, a significant profit impact. Factoring makes sense when: a cash constraint prevents pursuing profitable opportunities, the cost is less than alternative financing, or a short-term bridge is needed during a transition. It rarely makes sense as permanent financing because the effective interest rate is extremely high. Professional service firms should view factoring as an expensive last resort, not routine cash management.

Real-world example

Jennifer's firm won a large project that required significant contractor expenses before client payment. Cash gap: $85K for 60 days until client paid. Options: line of credit (did not have), factoring (immediate cash but expensive), or negotiate contractor terms. Chose selective factoring: factored just the $85K invoice at 3.5% ($3K fee) rather than establishing an ongoing factoring relationship. The $3K cost was acceptable for a one-time bridge enabling a $45K profit project. After project completion, Jennifer established a line of credit for future situations, recognizing that factoring was expensive for routine use.