What is Factoring in Finance and How Businesses Use It

Key Takeaways

1. Factoring lets businesses sell unpaid invoices whenever they need urgent cash. Companies (factors)  usually receive 80-90% upfront, and the rest (after fees) once customers pay.
    
2. It increases or stabilises the liquidity without using their assets as collateral. 
    
3. You need to pay factoring fees of 1-5%. Major risks are associated with customers’ trust as they deal with the third party rather than your company.
    

Factoring is a financial service where businesses sell their unpaid invoices to a third party (factor) for immediate cash. It helps improve cash flow without waiting for customers to pay.

For example, a textile company has invoices worth ₹10,00,000 due in 60 days. Instead of waiting, it sells them to a factor for ₹9,50,000 and gets instant working capital.

The table below briefly puts the working of factoring in finance.
 

You can see for yourself how factoring turns receivables into instant cash and gives businesses quicker access to funds.

Factoring in Finance is especially useful for small and medium businesses facing delays in customer payments. It improves liquidity, supports growth, and reduces the stress of waiting for long credit cycles. Let’s learn more about it and see how other businesses use it.

What Is Factoring in Finance?

Factoring in Finance is also called invoice factoring or accounts receivable financing. This is when a business sells its unpaid invoices to a third-party finance company (known as the factor). The invoices are sold at a discount, and in return, the business gets immediate cash instead of waiting weeks or months for customer payments.

Do you know that India’s factoring market grew to USD 133.3 billion in 2024 and is projected to reach USD 212.2 billion by 2033? It will have a CAGR of around 5.3% from 2025 onward.

This makes factoring a very popular tool for B2B businesses, such as manufacturers, wholesalers, or service providers, that often deal with delayed customer payments. Instead of taking a bank loan, they use their invoices to generate quick working capital and keep operations running smoothly.

How Factoring in Finance Works?

Factoring turns unpaid invoices into immediate cash by selling those invoices to a specialist (a factor). It’s a common short-term financing tool for businesses that need working capital fast.

It has a simple process. We have summarised its working in 3 steps.

1. The business (seller) sells one or more invoices to a factor.
2. The factor advances typically 80-90% of the invoice value upfront.
3. When the customer (debtor) pays the invoice, the factor returns the remaining 10-20% to the seller after subtracting factoring fees.

Here are the important characters or players involved in the whole process.

• Seller: the business that issued the invoice and needs cash now.
• Factor: the financing company that buys the invoice and handles collection.
• Debtor: the customer who pays the invoice.

For example, a supplier sells a ₹5,00,000 invoice to a factor. The factor advances 85%, which becomes ₹4,25,000 immediately.
When the debtor pays the full ₹5,00,000, the factor deducts a 3% fee, which is ₹15,000 and returns the remainder.

Remainder: ₹5,00,000 − ₹4,25,000 − ₹15,000 = ₹60,000 

This ₹60,000 goes to the seller.

The table below summarises the cash flow steps and amounts.
 

Factoring gives fast cash (the advance) while the factor handles collection; the seller ultimately receives the remaining balance minus fees. This speeds up cash flow, but costs (fees and any interest) should be compared to other financing options.

Benefits of Factoring in Finance

Factoring can be a real game-changer for businesses. It gives quick access to money and reduces the stress of chasing payments.

1. Immediate Cash Flow
Factoring provides instant working capital by advancing 80-90% of invoice value. Instead of waiting 2-3 months for payments, a business with a ₹10,00,000 invoice can immediately receive around ₹8,50,000. This helps cover salaries, rent, or purchase raw materials without delay.

2. No Collateral Required
Unlike bank loans, factoring doesn’t need property, machinery, or personal guarantees as security. Approval depends on the customer’s creditworthiness, not the business’s financial history. So, even small or newly established firms can secure cash flow using invoices worth ₹5,00,000 without pledging assets.

3. Focus on Growth
With payment collections handled by the factor, businesses save time and resources. They can use this freed-up cash to expand operations. For example, a company reinvests ₹4,25,000 received from factoring to purchase new equipment, boosting production and increasing revenue potential.

4. Bad Debt Protection (Non-Recourse Factoring)
In non-recourse agreements, if a customer defaults, the factor bears the loss. This protects the seller from bad debt risks. For example, a client is unable to pay ₹2,00,000. Under non-recourse, the factoring company is impacted, and the seller remains safe.

The table below summarises this section.

Factoring in Finance provides instant liquidity, reduces risk, and helps businesses channel their time and resources toward growth.

You would be shocked to know that factoring services in India generated USD 46 million in revenue in 2023. This report was submitted by Grand View Research. It further states that India can make a revenue of USD 115.2 million in 2030.

Drawbacks of Factoring in Finance

Despite its advantages, factoring is not flawless. Businesses must be careful of costs, risks, and potential impact on client relationships.

1. Costs Can Be High
Factoring isn’t free. Fees generally range from 1-5% of the invoice value, cutting into profit margins. For instance, on a ₹20,00,000 invoice, a 3% fee means losing ₹60,000. This recurring expense may be unsustainable for businesses with tight margins.

2. Customer Relationship Impact
When customers pay the factor directly, relationships may suffer. Instead of dealing with the business, clients interact with a third-party finance company. For some customers, this feels impersonal or signals financial weakness, potentially affecting trust and repeat business.

3. Recourse Risk
In recourse factoring, the seller remains responsible if a customer fails to pay. That means if a client defaults on ₹5,00,000, the business must return the advance. This risk makes recourse factoring less secure, especially for businesses with unreliable customers.

The table below summarises this section
 

Factoring in Finance is useful, but costs and risks can’t be ignored. Businesses should balance short-term liquidity against long-term profitability.

Conclusion 

There is a common issue that all businesses face, and that is liquidity or cash flow. If customers do not pay on time, it becomes difficult for a business pto pay their manufacturers. That is why big business opts for factoring infrastructures. Here, the unpaid invoices are sold to a third party. Though it comes with extra costs and risks, you need a strategy to implement it and balance the short-term liquidity with long-term customer trust and financial stability. 

Frequently Asked Questions

Does factoring attract GST or other tax on the factor’s fees?
Factoring fees are typically subject to GST (or local sales tax) and have tax implications for both the seller and the factor, so check treatment with your tax advisor.
 

Can I factor export or cross-border invoices?
Yes, export (international) factoring exists, allowing exporters to sell foreign receivables. However, it involves additional checks, FX risk and often different contract terms.

What industries commonly use factoring?
It’s widely used in logistics, textiles, manufacturing, and staffing. For instance, trucking companies factor invoices worth ₹50,00,000 monthly to manage fuel and driver costs while waiting for long payment cycles.

Can I factor only selected invoices, or must I factor the entire receivables book?
Most factors offer flexibility. You can factor individual invoices, selected customers, or the entire receivables ledger, depending on the agreement.
 

Are there fintech platforms that automate factoring?
Yes, several fintech marketplaces provide online onboarding, instant credit checks and faster funding. However, compare fees and recourse terms before switching.
 

Is factoring suitable for subscription or recurring-billing businesses?
Factoring can work for B2B recurring invoices, but subscription models with predictable cash flow may be better served by invoice discounting or subscription financing products.
 

What legal protections should I check in a factoring contract?
Review recourse vs non-recourse clauses, notification/assignment terms, dispute handling, and early termination fees to avoid unexpected liabilities. 
 

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