What is Factoring Accounts Receivable – A Complete Guide

Managing cash flow is one of the most critical parts of running a successful business. Even if you're closing big deals and sending out invoices regularly, a delay in payments from customers can severely impact your day-to-day operations. That’s where factoring accounts receivable comes in—a smart way to turn unpaid invoices into immediate working capital.

In this complete guide, you’ll learn everything about factoring and accounts receivable, how it works, when to use it, the benefits and drawbacks, key terms to know, and how it compares to other financing options. We’ll also break down the difference between factoring and accounts receivable financing, share common use cases, and provide a simple formula to understand the cost structure.

What Is Factoring Accounts Receivable?

Factoring accounts receivable is a financial transaction where a business sells its unpaid invoices to a third-party (called a "factor") in exchange for immediate cash. Instead of waiting for 30, 60, or even 90 days for your clients to pay, factoring lets you unlock capital tied up in your receivables.

You can typically receive 70% to 90% of the invoice amount up front. Once the customer pays, the factor sends you the remaining balance minus their fees.

This approach is ideal for businesses with regular invoicing but long payment terms or inconsistent cash inflows.

The Step-by-Step Process of Accounts Receivable Factoring

Let’s break down how factoring and accounts receivable work in real-time business scenarios:

1. Create and Deliver the Invoice

Your company delivers goods or services and sends an invoice to the customer with standard payment terms (Net 30, Net 60, etc.).

2. Submit the Invoice to a Factor

Instead of waiting, you send the unpaid invoice to a factoring company. The factor evaluates the invoice and the creditworthiness of your customer.

3. Advance Payment

Once approved, the factor provides you with an immediate cash advance—typically around 80% to 90% of the total invoice value.

4. Customer Pays the Factor

The customer pays the invoice directly to the factoring company as per usual payment terms.

5. Final Settlement

After receiving full payment, the factor sends the remaining balance to your business, minus a small service fee known as the factoring fee.

This makes accounts receivable factoring a fast and reliable way to convert receivables into usable funds without waiting on delayed client payments.

Key Types of Factoring in Accounts Receivable

1. Recourse Factoring

With recourse factoring, if your customer fails to pay the invoice, your business is responsible for repaying the advance to the factoring company. It’s the most common and affordable option.

2. Non-Recourse Factoring

In non-recourse factoring, the factor assumes the credit risk. If the client doesn’t pay, you’re not held liable. This offers added protection but typically comes with higher fees and stricter approval requirements.

Knowing which type suits your business helps avoid unexpected obligations and gives you more control over your cash flow strategy.

Understanding the Factoring Accounts Receivable Formula

Let’s look at how to calculate what you’ll receive from factoring:

Formula:

Advance Amount = Invoice Value × Advance Rate
Factoring Fee = Invoice Value × Fee Rate
Remaining Payment = Invoice Value – Advance – Factoring Fee

Example:

• Invoice Amount = $20,000
  
  
• Advance Rate = 85% → $17,000
  
  
• Fee = 3% of invoice → $600
  
  
• Final Payment After Client Pays = $20,000 – $17,000 – $600 = $2,400
  
  

So, your total cash from the transaction is $19,400 (with $600 retained as the factor's profit).

This transparent formula helps you understand the cost of using factoring in accounts receivable and supports better decision-making.

Difference Between Factoring and Accounts Receivable Financing

These two terms are often used interchangeably, but they’re distinct in structure and impact:

So, what’s the difference between factoring and accounts receivable financing? Factoring transfers responsibility and risk to the factor, while AR financing retains the invoice under your ownership as collateral for a loan.

Benefits of Factoring Accounts Receivable

Many businesses turn to accounts receivable financing vs factoring when comparing options. Here's why factoring stands out:

1. Faster Cash Access

You don't have to wait 30–90 days to get paid. With factoring, cash is typically delivered in 1–2 business days.

2. No New Debt

It’s not a loan. You’re not adding liabilities or interest payments to your balance sheet.

3. Credit-Flexible

Approval relies on your customer’s ability to pay—not your credit score.

4. Supports Business Growth

If your business is growing but your cash flow can't keep up, factoring helps fund expansion without waiting on receivables.

5. Scales with Your Business

The more you invoice, the more funding you can receive—no need to renegotiate limits like with traditional credit lines.

These benefits of factoring accounts receivable make it a versatile solution across industries and business sizes.

Typical Accounts Receivable Factoring Rates

Factoring fees vary by provider and risk factors. On average:

• Rates range from 1%–5% per 30 days
  
  
• Higher rates for riskier or longer terms
  
  
• Discounts for higher volume or long-term contracts
  
  

Factors that affect accounts receivable factoring rates:

• Creditworthiness of your clients
  
  
• Invoice volume
  
  
• Industry type (some are considered higher risk)
  
  
• Recourse vs non-recourse agreement
  
  
• Payment terms (longer = higher risk)
  
  

Always read the full agreement before signing—some providers add admin fees, processing costs, or hidden charges.

When to Use Accounts Receivable Factoring

Using factoring and accounts receivable is ideal when:

• Your clients have long payment terms (Net 30 or longer)
  
  
• You need to cover payroll or inventory quickly
  
  
• You want to fund growth without incurring debt
  
  
• Your business has seasonal revenue cycles
  
  
• You're waiting on large client payments but need liquidity now
  
  

Startups and fast-growing firms often use factoring to bridge funding gaps between invoice creation and payment collection.

When to Consider Other Options

While factoring is useful, it might not be the best fit if:

• You have a thin profit margin (fees may eat into gains)
  
  
• Your clients have poor payment histories
  
  
• You prefer to keep all client communication internal
  
  
• You already have low days sales outstanding (DSO)
  
  

In such cases, reviewing accounts receivable financing vs factoring can help you choose the right strategy.

Basil: Accounting Practice Management Software 

Before you reach the point of needing factoring, the best solution is a solid foundation. That’s where Basil comes in—a purpose-built accounting practice management software that helps accountants and firms stay organized, bill accurately, and get paid faster.

With Basil, you gain full visibility into your receivables, deadlines, and client communications—so your accounts receivable never spiral out of control.

 Basil’s Key Features for AR Management:

• Client Portals: Clients can upload, view, and download financial documents in a secure environment.
  
  
• Billing & Time Tracking: Track time spent on clients and convert tasks into invoices seamlessly.
  
  
• Unlimited eSignatures: Get client approvals instantly—no more chasing signatures manually.
  
  
• Task and Workflow Management: Automate recurring tasks, assign roles, and set invoice follow-up deadlines.
  
  
• CRM Tools: Track communication history, billing preferences, and client profiles all in one place.
  
  
• Team & Client Chat: Built-in chat makes collaboration easy and avoids lost email threads.
  
  
• 24/7 Human Support: Get help anytime, from real people who understand accounting workflows.
  
  

And the best part? Basil offers all of this for just $30 per user/month, with no hidden fees or paywalls.

Learn more or start your 15-day free trial at-  coraltreetech.com/basil

Top 5 FAQs About Factoring Accounts Receivable

1. Is factoring accounts receivable a loan?

No. It’s not a loan. You sell your receivables at a discount for cash. There’s no debt or interest payments involved.

2. How fast is funding after invoice submission?

Typically within 24–48 hours. Once the factor verifies the invoice and client, funds are deposited quickly.

3. How much does factoring cost?

Accounts receivable factoring rates vary but usually fall between 1%–5% of the invoice value per 30 days. Rates depend on industry, client credit, volume, and payment terms.

4. Will clients know I'm factoring?

Yes. In most cases, the client is notified and instructed to pay the factoring company directly. This is standard practice in factoring agreements.

5. Can I use factoring and still manage AR in my practice management software?

Absolutely. Using a system like Basil helps you keep clean records, track invoice timelines, and ensure everything is organized—making the factoring process faster and more transparent.

Conclusion

Factoring accounts receivable is a flexible financing strategy that offers immediate access to capital by selling unpaid invoices. It’s ideal for businesses facing cash flow challenges due to slow-paying clients or long payment terms.

While factoring isn’t for every situation, it’s a valuable tool when used strategically. That said, strong internal systems are your first line of defense—and that’s where Basil shines.

By using Basil’s accounting practice management software, you’ll gain better control of your receivables, reduce payment delays, and improve financial visibility—so you can grow confidently with or without factoring.

Ready to strengthen your AR process before factoring becomes a need?
Try Basil for free today. Start your 15-day trial