What Is Contract Factoring?

Key Features & Terms to Know

• Recourse vs. Non‐Recourse Factoring:

  • Recourse factoring means you (the business) remain liable if the customer doesn’t pay. The factor may require repayment or substitute invoices.

  • Non‐recourse factoring transfers more risk to the factor — if the invoice isn’t paid (due to credit‐worthiness issues), the factor eats the loss. But non‐recourse is usually more expensive. 

• Advance Rate: The percentage of the invoice paid upfront. The higher the rate, the more cash you get now, but often this comes with stricter conditions. 

• Factoring Fee / Discount Rate: The cost charged by the factor, often a percentage of the invoice amount or a periodic rate based on how long the invoice takes to be paid. Includes administrative, collection, processing fees. 

• Reserve: A portion of the invoice withheld by the factor until the invoice is paid; used to protect against losses or disputes.

• Eligibility Criteria: Factors often evaluate the creditworthiness of your customers, age and payment terms of invoices, whether invoices are undisputed, whether contract terms are met, etc.

Advantages of Contract Factoring

• Improved Cash Flow — You get funds much faster than waiting out customer terms. Useful if you need cash for operations, payroll, supplies, etc. 

• Faster Access to Capital — Factoring companies often advance funds within 24-48 hours once invoices/contracts are verified.

• Reduced Collection Burden — The factor typically handles collections, meaning less administrative work for you. 

• Risk Mitigation with Non-Recourse — If non-recourse, you’re protected against customer non-payment in certain cases. 

• No Traditional Debt — Since factoring is not a loan, you don’t incur debt in the same way; you are selling an asset (your receivables). 

Disadvantages & Things to Watch Out For

• Higher Costs — Fees can add up; non-recourse factored invoices are pricier. If invoices take a long time to pay, the cost increases. 

• Hidden Fees — Some factoring contracts include extra fees (administration, service charges, minimums, cancellation penalties, float days, etc.). Always read the fine print. 

• Contract Terms Can Lock You In — Auto-renewal, exclusivity, minimum invoice volume requirements may limit flexibility.

• Customer Relationship Implications — Some clients may prefer dealing directly, not through a factor. Also, the factor’s collection efforts affect your company’s image. 

Industries That Commonly Use Contract Factoring

• Construction, especially with milestone contracts or long project durations. 

• Government contracting, where payment terms tend to be long and bureaucratic. 

• Service businesses, engineering, architecture, or firms doing long-term contracts. 

How to Determine If Contract Factoring Is Right for Your Business

• Calculate your cash flow gap — how long you wait for invoices to be paid versus when you need cash.

• Estimate total factoring costs (advance rate, fees, reserve holdback). Compare to cost of bank loan or line of credit.

• Analyze your customer base: creditworthiness, payment terms, how many invoices are likely to qualify.

• Review multiple factoring agreements: compare rates, terms, hidden fees, cancellation terms, non-recourse vs recourse.

• Consider the impact on operations: collections, customer communication, and how factoring will affect relationships.