Factoring is a powerful tool for managing cash flow—but it comes at a cost. Many companies factor more than they need to, leaving significant margin on the table. Others avoid factoring entirely, creating cash flow stress that limits growth.
The right answer isn't "always factor" or "never factor." It's knowing when factoring creates value and when it destroys it. This framework helps you make that decision for each customer and situation.
Understanding the True Cost of Factoring
Factoring fees typically range from 1-5% of invoice value, but the true cost depends on how you calculate it:
Factoring Cost Calculation
Scenario: $100,000 invoice, 3% factoring fee, 45-day payment terms
Flat cost: $3,000 (3% of invoice)
Annualized cost: 24.3% APR ($3,000 ÷ $100,000 × 365 ÷ 45 days)
That 3% factoring fee is equivalent to borrowing at 24%+ annually. For comparison, a business line of credit might cost 8-12% annually.
But cost isn't the only consideration. Factoring provides immediate cash, eliminates collection effort, and often includes credit protection. The question is whether those benefits justify the cost for each specific invoice.
The Decision Framework
For each customer or invoice, evaluate these four factors:
1. Collection Probability
How confident are you that you'll collect in full if you don't factor?
Factor if:
- • Customer is high credit risk
- • You have limited collection resources
- • Industry has high default rates
Collect direct if:
- • Customer has strong payment history
- • Established relationship with good communication
- • Large, stable company
2. Cash Flow Need
How urgently do you need the cash from this invoice?
Factor if:
- • Need cash to fund new jobs/projects
- • Payroll or vendor payments due
- • Growth opportunity requires capital
Collect direct if:
- • Cash position is healthy
- • No immediate capital needs
- • Other financing available at lower cost
3. Collection Cost
What will it cost you to collect this invoice yourself?
Factor if:
- • Customer requires heavy collection effort
- • High dispute rate with this customer
- • Complex billing requiring documentation
Collect direct if:
- • Customer pays reliably with minimal effort
- • Straightforward invoicing, few disputes
- • You have efficient collection processes
4. Margin Impact
Can the job/transaction absorb the factoring cost?
Factor if:
- • High margin job (20%+)
- • You priced factoring into the bid
- • Cost of not doing the job is higher
Collect direct if:
- • Thin margin job where every point matters
- • Factoring would push job to break-even
- • Long-term customer relationship to protect
Running the Numbers
Here's a practical calculation to compare factoring vs. direct collection:
Factor vs. Collect Comparison
Invoice: $50,000 | Your margin: 15% ($7,500)
Customer typically pays in 60 days | Factoring fee: 3%
If you factor:
- • Cash received: $48,500 (immediately)
- • Factoring cost: $1,500
- • Net margin: $6,000 (12% of invoice)
If you collect direct:
- • Cash received: $50,000 (in 60 days)
- • Collection cost: ~$100-200 (staff time)
- • Net margin: ~$7,300 (14.6% of invoice)
- • Cost of waiting 60 days for cash: depends on your alternatives
The question: Is immediate cash worth $1,300 (the difference between $7,300 and $6,000)?
Optimizing Your Factoring Mix
Most companies should use a selective approach rather than factoring everything or nothing:
Tier 1: Always Factor
- New customers with no payment history
- Customers with poor credit or payment problems
- Large invoices that would create significant exposure
- Invoices where you need cash for immediate obligations
Tier 2: Factor Selectively
- Customers with occasional slow payment—factor when your cash is tight
- High-margin jobs that can absorb the cost
- Invoices with dispute risk where you want to transfer that risk
Tier 3: Never Factor
- Customers who consistently pay within terms
- Long-term relationships with predictable payment patterns
- Thin-margin jobs where factoring cost eliminates profit
- When you have sufficient cash and no immediate use for accelerated collection
Common Factoring Mistakes
Every invoice should be evaluated. Blanket policies leave money on the table.
If you know you'll factor an invoice, build the cost into your bid/price.
If you're factoring because you can't collect, fix the collection problem. Factoring should be a strategic choice, not a crutch.
Your factor relationship affects rates and availability. Manage it like any other vendor relationship.
Know your total factoring cost for each customer relationship. This affects pricing and credit decisions.
Reducing Factoring Dependency
If you want to factor less over time, focus on these areas:
Faster collection reduces the cash flow gap that makes factoring attractive.
Shorter terms mean faster cash without factoring costs.
More cash in the bank means less pressure to factor for liquidity.
A line of credit at 10% is cheaper than factoring at 24%+ annualized.
Better customer selection means fewer bad risks that require factoring protection.
Key Takeaways
- Factoring costs 1-5% per invoice, but 20-30%+ annualized—know the true cost
- Evaluate each customer/invoice on collection probability, cash need, collection cost, and margin
- Use tiered approach: always factor risky accounts, never factor reliable ones
- Improve collection capability to reduce factoring dependency over time