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Posted by Michael Noble - 16 September, 2021

How Accounts Receivable Factoring is a Pay Day Loan for Business

Picture this: 

Imagine not having any money, bills were due five days ago, and your paycheck won't arrive for another week and a half. You need $800 now, or you'll be evicted from your apartment. Family and friends don't have any money to lend. What do you do in this situation?

The above scenario plays out across America all the time. People who play musical chairs with their bills and paycheck sometimes find that there isn't a chair left to sit in. Out of desperation, they turn to the only financing option that will lend to them - payday loan companies.

It starts with the borrower handing over a posted dated check for the loan amount plus a fee in exchange for a cash advance. Payday loans charge some of the highest interest you'll find for consumer loans. 450% up to 850% is not uncommon. To give you an idea of how much that is, if you borrow $500 for 6 months at 450% interest, the monthly note will be $220. That's equal to $820 interest or 1.64X the original loan amount.

If the borrower is not able to pay the loan by its term date, the whole thing easily spirals out of control. Additional fees and a much higher interest rate are tacked on. Interest rates can shoot up well into the 1,000s. Someone who is barely able to put food on their table has no chance of getting out of this spiral without some help.

While the above picture may look bleak, it isn't an exaggeration. How does this relate to accounts receivable factoring? When a business runs low on cash and doesn't have any financing options, the payday loan equivalent is called accounts receivable factoring. Just as the payday loan lender is able to advance cash to a consumer, the factoring company is able to advance cash to businesses.

Accounts Receivable Factoring In 4 Sentences

For anyone who isn't familiar with accounts receivable factoring, here's how it works in 4 sentences. 

  1. A business allows a company called a factor to take over payment collections on outstanding invoices by selling its accounts receivable.
  2. The factor advances a percentage, usually 80% - 95%, of the accounts receivable invoices' value.
  3. The remaining percentage is held by the factor and paid once it is collected from customers.
  4. Once the remaining percentage is collected, it is sent to the business minus the factoring fee.

Using the payday loan example as an analogy, we'll go through each component of accounts receivable factoring.

The Posted Dated Check

Factors don't require a posted dated check. Instead, they want outstanding invoices. Just as a consumer must apply and get approval for a payday loan, so must a business apply and be approved for invoice factoring. Some of the qualifications include: must be B2B or B2G business, meet a certain volume of invoices per month, been in business for a certain number of years, and more depending on the factor.


High Interest

Factors don't charge interest. Instead, they charge fees, which can follow different structures. Some include a flat fee, tiered fee, and a fee plus the prime rate. While these fees aren't as high as a payday loan, they're still among the highest business financing fees. Fees can range from 1% to 5% of the factored invoices' value per month.

The fee is applied to the total amount of outstanding invoices, not just the advanced amount. As an example, a company factors $10,000 in total invoices at a rate of 4% per 30 days. It is advanced $8,500. Its total fee is $400 every 30 days.

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Additional Fees

Just as a payday lender can have setup fees, late fees, and more, some factors may also charge additional fees. These can include setup fees, monthly minimum fees, servicing fees, and early termination fees. Be sure the factor discloses that there can be additional fees along with a complete schedule of those fees.

The Spiral

When a payday loan borrower is not able to meet ever-growing loan payments, they fall behind, triggering more fees, higher interest, and still higher minimum payments. While the scenario with factors isn't as bad, companies can find themselves in a similar spiral.

Once a company's cash flow, and thus its working capital, begins declining, it will be unable to fund new projects for growth. In the most critical cases, lack of cash flow leads to an inability to maintain daily operations. At that point, a company is probably days away from filing for bankruptcy.

Other companies experience a temporary decline in cash flow. To get money coming back into the company, they may turn to a factor. Flush with cash, the company can continue funding growth but at the expense of revenue. Remember, the factor is taking a chunk of revenue with them.


For companies that are able to stabilize their cash flow but not get it back to where it was, they'll need another injection of cash. They turn to the factor for a quick fix and on it goes. These cycles can continue until the company is able to sustain itself (i.e., cash flow increases). Assuming a company meets the factor's qualifications, it's easy to get another infusion of cash at the expense of revenues.

The above is why accounts receivable factoring is a last resort as a financing option for businesses. Not only does factoring lop off a large amount of revenue, but additional fees can pile on, further decreasing revenue. 

Another component of factoring to consider is loss of control. Before factoring, a business collects payments directly from customers. What that customer experience looks like is completely up to the business. After invoice factoring, that entire process is taken over by the factor. What will customers think about this change? Hopefully, the business has informed customers ahead of time, and the factor will do a good job. If not, the business can have its work cut out in repairing relationships.


  • Accounts receivable financing helps you fund your business and get paid faster.
  • It is a cheaper and smarter alternative to bank loan financing.
  • There is no interest associated with accounts receivable factoring, but other fees can rack up your expenses.
  • It’s important to look at other methods of collecting cash when considering accounts receivable factoring.

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Topics: Finance, Funding, accounts Receivable, Loans

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Apruve enables large enterprises to automate long-tail credit and A/R so you can stop spending 80% of your time and resources on 20% of your revenue. We partner with each of our customers to solve their unique credit, payment, and accounts receivable challenges and build the right credit solutions for your markets, customers, and goals. 

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