Invoice Factoring for Contractors: How It Works, What It Costs

November 12, 202611 min read

Invoice factoring means selling an unpaid invoice to a finance company for cash now. The factor advances most of the invoice, usually 70 to 90 percent, within a day or two, collects from your customer, then sends you the rest minus its fee. The fee looks small, often 1 to 5 percent per 30 days, but it annualizes to somewhere between 20 and 60 percent. Factoring is a tool for a short, specific cash gap on a creditworthy commercial customer. It is an expensive habit for a business that simply bills late or collects slowly.

A busy contractor can be profitable on paper and still short on Friday. Payroll is weekly, suppliers want payment in 30 days, and the commercial client pays in 45 or 60. Factoring exists to close that gap. Here is how it works, what it really costs, where it breaks down for construction and service work, and what to try first.

How invoice factoring works

Factoring is a sale, not a loan. You are selling a receivable, the right to collect on an invoice for work you have already finished.

You finish the work and invoice the customer on your normal terms, say net 30 or net 45.
You submit the invoice to the factor. The factor checks your customer's credit, not yours, and confirms the invoice is real and undisputed.
The factor advances part of the invoice, usually 70 to 90 percent, often within 24 to 48 hours.
Your customer pays the factor directly. In most arrangements the customer is told to send payment to the factor's account.
The factor releases the remainder, called the reserve, minus its fee.

Two things follow from that. Approval depends on who owes you, so a young business with a strong commercial customer can qualify. And the factor now stands between you and that customer for collection, which changes the relationship.

What invoice factoring costs

Three numbers set the price.

The advance rate. The share of the invoice you get up front. General business factoring often advances 80 to 90 percent. Construction factoring tends to run lower, 70 to 80 percent, because construction invoices carry more risk of dispute and offset.

The factoring fee. Usually quoted as a percentage of the full invoice value per period, commonly 1 to 5 percent per 30 days. Some factors charge a flat fee; others use tiers, such as 2.5 percent for the first 30 days and 1.25 percent for each 15 days after. The longer your customer takes, the more you pay.

The extras. Application or setup fees, wire fees, monthly minimums, and termination fees on long contracts. Read for these before you compare headline rates.

The trap is in how the fee is quoted. It is charged on the whole invoice, but you only have the use of the advanced portion, and only for a month or two. A 3 percent fee on a $10,000 invoice with an 80 percent advance costs $300 for the use of $8,000 for 30 days. That is 3.75 percent a month, roughly 45 percent a year.

A worked example

A commercial HVAC contractor finishes a $40,000 rooftop unit replacement for a property manager on net 45 terms. Payroll and the equipment supplier are both due before day 45, so the contractor factors the invoice.

Invoice: $40,000
Advance rate: 85 percent, so $34,000 arrives in two days
Reserve held back: $6,000
Fee: 2.5 percent for the first 30 days, then 1.25 percent per 15 days
Customer pays on day 45: total fee is 3.75 percent of $40,000, which is $1,500
Reserve released: $6,000 − $1,500 = $4,500

The contractor collects $38,500 in total. The cost is $1,500 for the use of $34,000 for 45 days:

$1,500 ÷ $34,000 = 4.4% for 45 days, about 36 percent annualized.

Now put that against the job. If the job carried a 30 percent gross margin, the gross profit was $12,000. The factoring fee took $1,500 of it, one eighth of the profit on the job. If the customer had paid on day 75 instead, the fee would have been $2,500 and the bite closer to a fifth.

That is the honest way to judge factoring: not as "3.75 percent," but as a share of the profit on that specific job. If you do not know your margin by job, start with how to estimate profit margin on a job.

Recourse vs non-recourse factoring

Recourse factoring means that if your customer does not pay within a set window, often 90 days, you buy the invoice back or replace it with another. You carry the credit risk. It is the more common arrangement and the cheaper one.

Non-recourse factoring means the factor absorbs the loss if the customer cannot pay because of insolvency. It costs more, and the protection is narrower than it sounds. It covers a customer going bankrupt. It does not cover a customer who refuses to pay because they dispute the work, and in contracting, disputes are the more common reason an invoice stalls.

Why factoring is harder in construction

Many general factors avoid construction altogether, and the ones that specialize in it price for the risk. The reasons are structural.

Progress billing. An invoice for a percentage of completion is easier to dispute than an invoice for delivered goods. See progress billing for contractors.
Retainage. The 5 or 10 percent held until closeout is not collectible on normal terms, so factors will not advance against it. See how retainage works in construction.
Pay-when-paid clauses. A subcontractor's invoice may depend on the owner paying the general contractor first.
Lien rights and offsets. Unpaid suppliers can file liens, and customers can deduct back-charges. Both cut into what the factor can collect. Lien waivers are part of the paperwork a construction factor will ask for.

Service businesses billing for completed, undisputed work, such as a finished repair, a month of janitorial service, or a delivered maintenance visit, are a cleaner fit than a builder billing draws on an open project.

Funding for recurring service contracts

A common question is whether a signed maintenance contract can be factored. Generally it cannot. A factor buys invoices for work already performed. A twelve-month contract is future revenue, not a receivable, until each period is delivered and billed.

What you can do is factor each monthly invoice as it is issued, or use the contract itself as evidence of stable revenue when applying for a bank line of credit. The better fix is usually in the contract terms: bill recurring work in advance, at the start of each period, so the customer funds the work rather than a lender. Recurring maintenance contracts covers how to structure them.

When factoring makes sense

A large, creditworthy commercial customer on long terms that you cannot shorten, and the job is profitable enough to absorb the fee.
Fast growth, where each new job needs labor and materials paid before the last job has collected.
A one-time gap, such as a big job landing at the same time as a seasonal slow stretch.
No access to cheaper credit yet, because the business is new or the owner's credit is thin.

It makes less sense for residential work, where customers can pay on completion, for thin-margin jobs where the fee erases the profit, and as a permanent fixture. A business that factors every invoice all year is paying a third of its profit, or more, to cover a collections problem.

Cheaper ways to close the gap first

Before selling invoices, pull the levers that cost little or nothing.

Shorten your terms. Net 30 is a habit, not a law. Many service businesses can bill due upon receipt or net 15. The full menu is in invoice payment terms explained.

Collect a deposit. A deposit before work starts funds the materials with the customer's money. See how to collect a deposit before work.

Invoice the day the work is done. Every day between finishing and invoicing is a day added to your wait at no benefit to anyone.

Make paying easy. An invoice with a pay button gets paid faster than one that needs a mailed check. A card processing fee of around 3 percent, paid once, is far cheaper than a factoring fee that keeps growing while the customer waits.

Offer an early-payment discount. 2/10 net 30 costs you 2 percent and works on customers who would otherwise take the full term. It is not cheap either, but you control it and no third party contacts your customer.

Follow up on a schedule. Most late invoices are forgotten, not refused. Payment reminder emails and a weekly look at your aging do most of the work. See how to track accounts receivable.

Open a line of credit before you need it. A bank line usually costs a fraction of factoring. It takes longer to get and depends on your own credit and history, which is the reason to apply while cash is healthy.

Then measure the result. Days sales outstanding tells you how long your money sits with customers, and cash flow management for a service business puts the whole picture together.

Questions to ask a factor before you sign

Is the fee flat or tiered, and what does a 60-day and a 90-day payment cost?
Is it recourse or non-recourse, and what exactly does non-recourse cover?
Can I factor single invoices, or must I factor every invoice from a customer, or my whole ledger?
Is there a monthly minimum volume, and what do I pay if I fall short?
How long is the contract, and what does it cost to leave early?
How will you contact my customer, and what will the notice say?
Do you file a lien on my receivables or other business assets, and how is it released?

Question three matters most to a small business. Spot factoring, one invoice at a time, costs more per invoice but leaves you free. A whole-ledger contract with a monthly minimum can lock you into paying fees on invoices you never needed to fund.

FAQ

Is invoice factoring a loan?

No. It is the sale of a receivable. You do not take on debt, and approval rests mainly on your customer's credit. With recourse factoring you can still owe the money back if the customer does not pay, so it carries loan-like risk.

How much does invoice factoring cost?

Typically 1 to 5 percent of the invoice per 30 days, plus any setup, wire, or minimum-volume fees. Because the fee is charged on the full invoice while you receive only the advance, the effective annual cost commonly falls between 20 and 60 percent.

Will my customer know I am factoring?

Usually yes. Most factors notify the customer and redirect payment to their own account. Large commercial customers see this often and rarely object, but it is worth a short call from you before the notice arrives.

Can I factor invoices for residential customers?

Rarely. Factors want invoices owed by established businesses or government bodies with checkable credit. Residential work is better served by deposits and payment on completion.

What is the difference between factoring and a line of credit?

A line of credit is borrowing against your own creditworthiness at an interest rate, and it is normally much cheaper. Factoring is selling invoices based on your customer's creditworthiness, and it is faster to obtain. Many businesses use factoring until they qualify for a line, then switch.

Does factoring fix a cash flow problem?

It moves cash forward once. If the cause is slow invoicing, long terms, or weak follow-up, the gap returns with the next invoice and the fee comes with it. Fix the cause and factoring becomes an occasional tool.

This article is general information, not financial advice. Rates and contract terms vary by provider; read the agreement and talk to your accountant before you sign.

Getting started with CRMb

Most cash gaps start as billing gaps. CRMb turns an accepted quote into an invoice with its deposit and terms, sends the client a link they can open and pay online, reminds them when a balance runs late, and shows what every client owes and how old it is. Your bank activity sits beside it, so a deposit that matches an open invoice settles it in a tap.

Start a 14-day free trial and see how much of the gap closes without selling a single invoice.