Business invoice factoring: Pros, cons & how it works

Every business needs a capital injection to cover daily expenses, take on new opportunities, or keep things running smoothly.

Traditional financing options, like bank loans, are great but often come with long approval times, paperwork, and rigid requirements.

That’s where alternative options, like invoice factoring, come into play.

With it, you don’t need to wait for customer payments to trickle in. Instead, you can instantly unlock the cash tied up in your unpaid invoices.

‍This financing method allows you to maintain your cashflow without adding debt to your books or stressing about credit scores.

It’s quick, convenient, and often a lifeline for businesses that need capital quickly.

So, is invoice factoring the right move for your business? Let’s examine how it works, its advantages and disadvantages, and whether it’s worth considering.

What is invoice factoring?

Invoice factoring, or accounts receivable factoring, is a financial arrangement where a business sells its unpaid invoices to a third-party company.

This third party, known as the “factor,” provides immediate cash against those invoices. It's a helpful solution for small and medium-sized businesses (SMBs) needing quick access to funds.

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👉 Invoice factoring is just one of many ways to secure funds. Check this list of fast, flexible funding options to fuel your business growth in 2025 and beyond.

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How does invoice factoring work?

Factoring involves several steps.

First, a business applies to a factoring company.

Then, the factor assesses the brand’s creditworthiness, the reliability of its customers, and the quality of the invoices.

If approved and both parties agree to the terms, the factor advances a percentage—between 70% and 90%—of the invoice amount, usually within 24 to 48 hours.

Customers then pay the invoices directly to the factoring company, which handles collection.

After payment, the factor deducts their fees and any advances before releasing the remaining balance to the business.

How much does invoice factoring cost?

Factoring companies charge a discount fee, usually between 1% and 5% of the invoice value per month, depending on how long it takes for the customer to pay.

In addition, many companies charge service fees, ranging from 0.5% to 2.5% of the invoice value, to cover administrative costs.

To better understand the concept, consider this example: you run a furniture manufacturing business with $1,000 (roughly around ₹84,075.60) in unpaid invoices with Net-30 payment terms.

Instead of waiting a month for your customers to pay, you can sell these invoices to a factoring company. 

After checking the requirements, let's assume that the factor agrees to give you 85% of the total invoice. So, you get $850 (around ₹71,464.26) immediately to fund your emergency expenses.

Once the factor receives the full payment from your customer, they deduct the fee and any other charges and return the remaining funds to your account. 

For the sake of this scenario, let’s say there’s a 3% fee ($30—around ₹2,522.27) and a 2% service charge ($20—around ₹1,681.51).

So, after everything’s settled, you’ll receive $100 (₹8,407.56) in your account. 

Here’s how this is calculated:

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Invoice amount = ₹84,075.60

Upfront payment = 85% of ₹84,000 = ₹71,464.26

Fees & charges = 3% of ₹84,075.60 + 2% of ₹84,075.60 =₹4,203.78

Additional amount transferred = (₹84,075.60 -₹71,464.26)-₹4,203.78 = ₹8,407.56

Advantages of invoice factoring

Like any other financing model, invoice factoring has advantages and disadvantages. Various elements, including costs, customer connections, and profit margins, can all play a role.

On one hand, it provides instant access to funds, solving cashflow issues.

However, there are costs and considerations associated with it.

That said, let's first take a closer look at the advantages:

1. Improved cashflow

Cashflow can make or break a brand, especially for small and medium-sized enterprises (SMBs).

‍Invoice factoring helps overcome this problem by allowing you to turn unpaid invoices into immediate capital. 

You get most of the money upfront rather than waiting weeks or months for customers to pay.

This keeps your operations running smoothly and lets you meet your financial obligations, such as payroll, utilities, and rent, without delay.

2. Faster access to funds

Traditional financing methods, like bank loans, can take weeks (or longer) to process. This wait can be frustrating for businesses in need of immediate cash.

With factoring, funds are typically available within 24 to 48 hours of submitting your invoices. 

This speed is especially useful when you face unexpected expenses or need to take advantage of a time-sensitive opportunity, like a bulk inventory purchase at a discounted rate.

You can secure the funds quickly and keep your business moving forward.

3. No additional debt

One of the biggest advantages of invoice factoring is that it doesn’t require you to take on additional debt.

You’re not borrowing money—you’re simply selling your invoices for immediate cash.

Plus, there are no long-term debt obligations. This means your balance sheet stays clean, and you don’t have to worry about monthly repayments. 

Avoiding extra debt can be an enormous relief for businesses already dealing with loans or credit lines, as it reduces financial strain and lowers the risk of over-leveraging.

4. No giving away equity

Many businesses turn to investors or venture capital when they need funding, often giving up some ownership.

‍Invoice factoring is a type of non-dilutive financing. It offers a way to raise capital without sacrificing equity. 

You control your business fully, allowing you to decide freely without outside influence.

This is especially important for small business owners who want to grow their company on their terms without diluting ownership or sharing profits.

5. Enhanced business growth

With cashflow no longer a concern, you can focus on growing your business.

Whether it’s purchasing more inventory, hiring additional staff, or investing in new equipment, invoice factoring frees up the capital you need to expand. 

Quick access to funds enables flexibility in pursuing new opportunities. It gives you the financial breathing room to plan for growth rather than just survival.

6. Better credit management

Invoice factoring shifts the focus from your business’s credit score to that of your customers.

Even if your business doesn’t have a stellar rating, you can still take advantage of factoring. 

The factoring company looks at the payment reliability of your customers, so if they have good credit and pay on time, you’ll likely qualify for factoring. This makes it a viable option for businesses that may have been turned down for loans due to poor or limited credit history.

7. Reduced administrative burden

Factoring companies often take over the responsibility of collecting payments from your customers.

Outsourcing this task to the factoring company frees up time to focus on more important aspects of your business, like sales, marketing, or product development. 

The factor also reduces the stress of dealing with slow-paying customers, as you no longer need to deal with them.

This can be a huge source of solace, removing the hassle of chasing down late payments and managing accounts receivable. 

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👉 Cash crunch holding you down? Here are four effective tips to prevent cashflow problems in your business.

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Disadvantages of invoice factoring

While invoice factoring offers many advantages, it’s important to consider the potential downsides before deciding if it’s the right choice for your business.

Here are some key disadvantages to keep in mind:

1. Higher costs

Factoring companies often charge a range of fees that reduce the total cash you receive. These may include upfront fees, discount rates (a percentage of the invoice value), and occasionally reserve fees.

These costs are typically higher than bank loans and other traditional financing methods.

While it gives you quick access to funds, the overall expenses can significantly affect your business’s earnings.

2. Limited suitability for certain businesses

Factoring is most effective for companies that frequently issue invoices to other businesses (B2B).

Industries such as manufacturing, logistics, and construction often benefit from this financing option.

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However, it may not work well for companies serving individual consumers (B2C) or businesses with sporadic or lower-value invoicing patterns.

Due to these inconsistencies, smaller retailers or service providers may find it less advantageous.

3. Strict requirements

Not every business is eligible for invoice factoring. Lending companies primarily assess the creditworthiness of your clients rather than your financials.

Securing a deal with a factoring company may be hard if your customers have unreliable or poor payment histories.

Additionally, some companies may set minimum invoice values, which could exclude smaller organisations from participating.

4. Negative impact on customer relationships

Bringing in a third party to manage invoice collections can change how your clients view your business.

Some may perceive it as a sign of financial trouble, raising concerns about your stability.

Furthermore, if the factoring company uses aggressive tactics to collect payments, it may strain relationships with important customers, potentially affecting future business.

Alternatives to invoice factoring

While invoice factoring is quite popular for quick cashflow, other funding routes are also available.

These include traditional methods like loans and non-traditional or alternative financing options like invoice financing. 

Let’s explore both categories in detail:

Traditional financing options

This model usually involves banks or financial institutions and requires a more formal process. It’s best suited for established businesses with solid credit histories.

Some of the most popular choices are:

1. SME/MSME loans 

These are available through banks or government schemes, offering low interest rates and larger funding amounts. They’re ideal for businesses with a solid credit history.

However, they often require collateral and take longer to process, making them less suitable for urgent needs.

2. Business line of credit 

This flexible option allows you to borrow as needed, paying interest only on the amount used.

It’s perfect for managing cashflow gaps but can come with higher interest rates. It suits businesses with fluctuating revenue, like those with seasonal demand.

3. Term loans

These are lump sum funds you can repay over a fixed period. They’re ideal for funding long-term projects.

The fixed repayment schedule offers predictability but comes with a slower approval process, requiring strong credit and often collateral. It works best for brands with an established presence.

Non-traditional financing options

These options cater to businesses with varying cashflow needs and are often more flexible in structure.

Unlike their traditional counterparts, alternative financing provides quicker access to funds with lesser complexities.

Some common choices include:

1. Invoice financing

Unlike factoring, where you sell the invoices, this financing model uses your unpaid invoices as collateral for a loan. You keep control of collections and customer relationships, making it less intrusive.

However, it still involves interest and fees you must repay monthly.

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👉 Are you curious if alternative financing is right for your business? Dive deeper into the specifics of invoice factoring for small businesses and discover its benefits.

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2. Revenue-based financing (RBF)

This involves receiving upfront capital for a fixed percentage of future revenues.

The key benefit is its flexibility—payments adjust according to income, which is helpful during slow sales. It’s ideal for businesses experiencing growth and looking to expand without taking on debt or giving away equity.

3. Merchant cash advance (MCA)

Merchant cash advance or MCA offers fast funding in exchange for a share of your daily credit card sales. It’s ideal for businesses with steady credit card revenue, like restaurants or retail shops, that need immediate cash.

However, it has higher fees and can quickly become expensive to finance short-term needs.

4. Peer-to-peer (P2P) lending

This connects businesses directly with individual investors, offering a quicker financing route than banks. It works best for small businesses and startups needing quick cash without the lengthy bank approval process.

However, interest rates and terms may vary widely, so careful consideration is necessary.

💡Our tip: explore multiple options and compare the terms and conditions before deciding. If necessary, consult with a financial advisor to determine the best financing solution for your business.

Get funds on your terms and grow without restrictions with Stenn

At Stenn, we recognize cashflow control is vital for your business.

Traditional invoice factoring often means receiving less than the full invoice value and various fees that can further squeeze your margins.

Plus, it involves lengthy processes where the company (factor) reviews your worthiness and that of your customers.

In contrast, our invoice factoring solution allows you to unlock the funds you need while maintaining control over your operations.

Whether you’re an importer looking to strengthen supplier relationships or an exporter wanting to reduce payment terms, it adapts to your unique business requirements.

We're excited to announce our partnership with Payyd, bringing invoice financing directly to businesses in India.

This collaboration enables you to secure fast, collateral-free funding tailored to your needs.

Our streamlined process ensures you can access funds within 48 hours of approval. You can unlock up to 90% of your invoice value immediately, giving you the flexibility to manage your cashflow effectively. 

Apply for Stenn financing today and transform how your business manages liquidity.

With our seamless digital application process and competitive rates, there's never been a better time to fuel your business growth.