What Is Invoice Factoring?
Learn how invoice factoring converts unpaid invoices into immediate cash by selling receivables to a third-party factor at a discount.
Key Takeaways
- Invoice factoring is the sale of unpaid invoices to a third party (factor) at a discount in exchange for immediate cash.
- Factors typically advance 70-90% of the invoice value upfront and pay the remainder minus fees when the buyer pays.
- Unlike loans, factoring is based on the creditworthiness of the buyer, not the seller, making it accessible to younger businesses.
How Invoice Factoring Works
Invoice factoring involves selling your outstanding invoices to a factoring company at a discount. When you issue an invoice with 30, 60, or 90-day payment terms, instead of waiting for the buyer to pay, you sell that invoice to a factor. The factor advances you 70-90% of the invoice value immediately. When the buyer pays the full amount, the factor remits the remaining balance minus their fee, which typically ranges from 1-5% of the invoice value depending on the payment period and risk profile.
Factoring vs Traditional Lending
Unlike bank loans, factoring does not create debt on your balance sheet. The factor purchases your receivable, not lends against it. Approval depends primarily on your customers' creditworthiness, not yours, which makes factoring accessible to startups and businesses with limited credit histories. Processing is faster than traditional loans, often funding within 24-48 hours. However, factoring is typically more expensive than bank financing, with effective annual rates often exceeding 15-30% when fees are annualised over short payment cycles.
Recourse vs Non-Recourse Factoring
In recourse factoring, you remain liable if the buyer fails to pay. The factor can demand repayment of the advance if the invoice goes uncollected. This is the more common and cheaper arrangement. In non-recourse factoring, the factor absorbs the credit risk: if the buyer defaults, you keep the advance. Non-recourse fees are higher because the factor bears the loss risk. Many factors offer a hybrid model, covering buyer insolvency but not payment disputes arising from goods or service quality issues.
Invoice Factoring in African Markets
Factoring is growing rapidly across Africa as a solution to the chronic cash flow challenges facing SMEs. South Africa leads the continent with a developed factoring market. Nigerian fintechs like Lidya and Mines.io offer digital factoring products. In East Africa, platforms are emerging that factor invoices from suppliers to large corporates and government entities. The African Export-Import Bank (Afreximbank) actively promotes factoring through its Intra-African Trade Programme, recognising it as a tool to close the continent's trade finance gap.