Factoring for Small Businesses: Selling Receivables to Gain Liquidity

Why a full order book can empty the till

A business delivers, issues an invoice, and waits. In the first half of 2026, the average payment term in German B2B business was 32.21 days, and small companies waited an additional 10.52 days beyond the term on average (Creditreform). During this time, materials, wages, and VAT have already been paid. When sales grow, so does the amount tied up in open invoices. The article Growth costs cash describes this gap with the cash conversion cycle: days inventory plus days receivables minus days payables.

The central question, then: When is factoring a sensible route to more liquidity for a small or midsize business, and when is it too expensive or too risky? To answer it, we first clarify the forms, introduce the mental model of borrowed creditworthiness, work through an example, and weigh two views.

What factoring is: forms and terms

Factoring is the ongoing sale of receivables from goods and services to a specialized financier, the factor. The supplier receives a large part of the invoice amount immediately. The remainder, the reserve, is paid out by the factor once the customer has paid. It differs from reverse factoring, described in the Greensill case study, in who takes the initiative: in ordinary factoring, the supplier sells its receivables itself; in reverse factoring, the buyer confirms its supplier’s invoice.

Factoring is thus financing, protection, and service at the same time. The protection resembles trade credit insurance, with one difference: insurance pays only when a loss occurs, while factoring brings the money immediately. When insurance alone is enough is described in Trade credit insurance: when it pays off. The basic rule from Financing business growth applies here as well: the term of the financing matches the useful life of what is being financed. Factoring finances short-term receivables in the short term; it is not suited to a machine.

The mental model: borrowed creditworthiness

Leora Klapper (2006), in a widely cited study for the World Bank, explained why factoring can help small businesses in particular. Her core argument: a bank lending to a small business has to assess its future, and it knows little about it. A factor, by contrast, buys receivables from customers that are often larger and better known. The risk therefore depends mainly on the creditworthiness of the buyers. Because the receivables are sold rather than merely pledged, they do not form part of the supplier’s estate in its insolvency. A supplier with high risk of its own can thus transfer its credit risk to better debtors.

I call this the principle of borrowed creditworthiness. An everyday analogy: someone who wants to rent an apartment and cannot prove their own income brings a guarantor with a steady salary. The landlord then mainly looks at the guarantor. In factoring, the business’s customers are this guarantor, except that they notice little of it as long as they pay on time.

Factoring is the loan for which not your business stands surety, but your customers.

What research and market figures show

Using data from many countries, Klapper (2006) found that factoring is larger where the economy is more developed and growing faster and where good credit bureaus exist. That fits the mental model: a factor needs information about the customers. Where it is missing, the factor cannot assess the borrowed creditworthiness.

Jieh-Haur Chen and Wei-Hsiang Chen (2012) broke down the costs of factoring for a building contractor in Taiwan. They split them into three parts: the factor’s commission, the cost of advance financing until payment, and the cost of credit monitoring. In their simulation of a construction project, the costs of non-recourse factoring came to only 0.8 percent of project costs, less than most conventional financing. As advantages, they cite faster cash inflow, less effort in receivables management, and the transfer of default risk. The calculation rests on assumptions about interest and payment terms in Taiwan and considers only the general contractor, not its subcontractors.

The domestic part grew by 8 percent to 302.9 billion euros in 2025, the international part by 1.9 percent to 120.5 billion euros. The strongest factoring sector was once again trade, followed by healthcare and the food industry. In Germany, factoring is therefore no longer a niche product but a widespread way of financing working capital.

Worked example: what factoring costs and what it brings

In the example, a wholesaler sells 3 million euros a year to business customers. With days receivables of 45, around 370,000 euros are outstanding on average. The factor pays out 90 percent immediately, about 333,000 euros. It charges a fee of 1 percent of turnover and 6 percent interest on the advance.

In this example, costs of 50,000 euros are set against 45,000 euros of benefit. Factoring would thus be slightly more expensive. It turns positive if the freed-up money also enables growth that would otherwise have failed for lack of liquidity: if an additional order of 300,000 euros at a 10 percent contribution margin brings 30,000 euros, the whole thing clearly pays off. Without such a purpose, factoring remains an expensive way of having money earlier.

Two views: growth aid or expensive dependence?

The first view sees factoring as a growth aid. Financing grows with sales, without a new loan negotiation. According to the survey of small and midsize firms cited in the article How banks decide on loans, 40.5 percent of them experienced their bank as restrictive in loan negotiations in the second quarter of 2026. Factoring depends less on the bank and more on the customers. Non-recourse factoring also shortens the balance sheet and can improve the equity ratio.

The second view sees an expensive dependence. Fees and interest are often higher than the cost of an overdraft line. In notified factoring, the customer learns of the assignment, and some interpret this as a sign of financial weakness. Contracts often contain minimum terms, minimum volumes, and the obligation to offer all receivables. And anyone who gets used to quick money has a problem when the factor stops buying receivables from an important customer.

I consider the first view the stronger one when factoring serves a clear purpose: financing growth, using early-payment discounts, passing on default risk. The second applies when factoring covers up a structural earnings problem. Then it only postpones the problem and makes it more expensive. That the design of the financial statements also plays a role is shown by Accounting policy and accounting fraud: factoring is a permitted structuring of transactions, but anyone who conceals it from the bank and shareholders damages trust.

The check before signing a factoring contract

1. Define the purpose

   What will the freed-up money be needed for: growth, early-payment discounts, default protection? Without a purpose, the basis for the calculation is missing.

2. Check the receivables

   Are the customers businesses with good credit standing, and are invoices rarely disputed? Only then does borrowed creditworthiness work.

3. Calculate all costs

   Add up fee, interest, per-customer review fees, minimum volume, and the cost of the reserve, and compare with overdraft line and loan.

4. Read the contract

   Clarify term, notice periods, obligation to offer receivables, and how declined customers and complaints are handled.

5. Inform customers

   In notified factoring, inform your most important customers yourself in advance and explain the step with its purpose.

Conclusion: when factoring makes sense

To the guiding question: factoring makes sense for a small or midsize business when it supplies solid business customers, wants to grow faster than equity and bank loans allow, and can put the freed-up money to profitable use. The mental model of borrowed creditworthiness according to Klapper explains why it works: the factor mainly assesses the customers, not the business. Factoring is too expensive or too risky when it has no clear goal, when receivables are disputed or customers weak, and when it is meant to cover up an earnings problem. The limits of this article: the study by Chen and Chen rests on a simulation in Taiwan, and the worked example uses freely chosen figures.

1. This week: Calculate your days receivables and note how much money is tied up in open invoices on average.
2. Next week: Define what freed-up money would specifically be used for and calculate the benefit.
3. After that: Obtain two offers and compare them in full with an overdraft line and credit insurance.

Anyone who uses factoring is selling time. That only pays off if they earn more with that time than it costs.