Invoice Factoring Explained: What It Is, How It Works, and Alternatives

Invoice factoring is a form of business finance where a company sells its invoices to a third party — called a factor — at a discount, in exchange for immediate cash. It has been used for decades by businesses that need to access funds tied up in unpaid invoices.

Here is a plain English explanation of how it works, what it costs, and what alternatives are available.

How Invoice Factoring Works

The process typically works as follows:

1. A business raises invoices against its customers
2. Those invoices are sold to a factoring company
3. The factoring company advances a percentage of the invoice value — typically 70-90% — to the business
4. The factoring company contacts the customer directly to collect payment
5. When the customer pays, the factor releases the remaining balance to the business, minus their fees

Key Characteristics of Traditional Invoice Factoring

Whole-ledger commitment: Most traditional factoring arrangements require the business to assign all invoices from its debtor ledger to the factor — not just selected invoices.

Debtor notification: Customers are typically notified that their invoices have been sold and that payment should be made to the factor, not to the business. This means customers are aware of the financing arrangement.

Ongoing contracts: Factoring arrangements often involve fixed-term contracts — typically 12 months or more.

Collection by the factor: The factor typically manages collections from the debtor, which removes this task from the business but also means the business has less control over customer relationships.

Costs

Factoring fees typically include a service fee (0.5-3% of invoice value) and sometimes a discount fee (interest on the advance). The total cost varies significantly by provider and the quality of the debtors.

Who Invoice Factoring Suits

Traditional invoice factoring tends to suit businesses that:

• Have consistent, high-volume invoicing
• Do not mind their customers knowing about the arrangement
• Want to outsource debtor management
• Are comfortable with whole-ledger commitment

Alternatives to Traditional Invoice Factoring

The invoice finance market has evolved significantly, and businesses in Australia and New Zealand now have access to more flexible options that address the main limitations of traditional factoring.

Selective invoice finance (FundTap): Rather than assigning all invoices, businesses choose specific invoices to fund. There is no whole-ledger commitment, no debtor notification, and no long-term contract. Funds are available within hours through integration with Xero, MYOB, or QuickBooks.

For businesses that want the cash flow benefit of invoice factoring without the restrictions — the debtor notification, the whole-ledger commitment, and the ongoing contracts — selective invoice finance like FundTap offers a more flexible alternative.