The Complete Behind the Scenes Guide
The Complete Behind the Scenes Guide on How Invoice Factoring Really Works in 2026: Credit, Payments, Verification & Cash Flow
Invoice factoring is one of the oldest, most flexible, practical forms of working-capital financing available today, but most business owners only understand the surface-level version: “sell invoices, get cash.”
Behind the scenes, factoring is a partnership built on customer credit, predictable payment behavior, clean invoicing, and transparent communication. When you understand how the process actually works, you’ll get smoother funding, faster reserve releases, lower fees and a more productive long-term relationship with your factoring company.
This guide breaks down the seven core parts of a factoring relationship:
- Customer Credit
- Customer Payments
- Notice of Assignment
- Reserve Accounts
- Verification of Invoices
- Invoice Monitoring & Collections
- Submitting Invoices for Funding
1. Customer Credit: The Foundation of Every Factoring Relationship
Factoring really comes down to one thing: the creditworthiness of your customers, not your business. That’s what drives advance rates, discount percentages, credit limits, and funding decisions.
What Factors Review at the Start
A factoring company will typically begin by reviewing your accounts receivable aging report, looking at:
- Open balance amounts: Are receivables concentrated with a few large customers or spread out?
- Aging: Do customers consistently pay on time, or are they stretching terms
- Type of aging report: Due date vs. transaction date aging helps the factoring company understand true payment performance.
After that quick review, the factor zeroes in on your largest customers and begins running commercial credit checks using Dun & Bradstreet, Experian, or Equifax.
Credit Limits & Why They Don’t Always Match Yours
Invoice Factoring Companies establish credit limits for each customer, which are often different from the limits you feel comfortable extending. This difference is one of the most common frustrations for new factoring clients.
From your view:
You know your customers, their people, and their habits.
From the factor’s view:
They’re relying on verified data, credit files, payment trends, public records, and your own historical experience.
Remember, factors only earn money when they buy invoices, so turning down an invoice is never their goal. If they decline or cap funding, there’s usually a real credit or payment concern driving it.
How Payment History Affects Limits
Consistent, timely payment builds confidence. As customers prove themselves, your factoring company may raise their credit limits. If payment behavior slips or becomes inconsistent, limits may be reduced or get suspended.
Reliable customer payments, equal smoother funding and stronger more reliable cash flow.
Ongoing Credit Reviews
Good factors don’t “set it and forget it.” They re-review customer credit every 90 days (or sooner if balances increase or invoices start aging). This protects you, ensures proactive credit monitoring and helps prevent surprise non-payment.
Using Your Factor as a Credit Department
Most factoring companies give clients access to credit tools, even for customers you aren’t factoring.
This is massively underutilized.
Factoring companies review thousands of businesses. They understand payment trends, red flags, slow-pay patterns, and industry risk signals. Their insight can:
- Prevent bad-debt
- Help you set smarter credit limits
- Guide decisions on onboarding new customers
When your factor offers to run credit, let them! Use their experience and expertise to help you make good credit decisions. After all, its generally free!
2. Customer Payments: How Money Flows Through a Factoring Relationship
Your customers’ payments should go directly to the factoring company, whether by check, ACH, or wire. This ensures the factor is repaid for the funds advanced.
Because factoring agreements include a power of attorney, factors can deposit checks even if they’re made out to your business.
How Payments Are Posted
Once received:
- The factor deposits the payment.
- Banks typically show credit the next business day.
- The payment is matched to the corresponding invoices.
- You see it reflected in your online collection reports.
If the payment applies to factored invoices, it pays down your balance. If it’s non-factored, it still appears in your account as “Non-Factored Cash.” Most factoring companies simply pass through non-factored collections.
Unidentified Payments
ACH and wire payments often arrive without full remittance details. When the factor can’t match a payment to an invoice, they’ll contact you for clarification.
Until identified, it sits in Unidentified Cash, and not credited to your account.
The faster you track it down, the faster it goes to work for your cash flow.
Stay Synced with Your Accounting
It’s smart to post payments into your accounting system daily. Your factor has already matched payments to invoices, use their reports to stay accurate and reconciled.
3. Notice of Assignment: The Legal Backbone of Factoring
Factoring isn’t a loan, so repayment flows directly from your customers to the factoring company.
To make this official, your factor sends a Notice of Assignment (NOA) to your customers. This letter simply states:
- Your receivables have been sold and assigned.
- Payments must go to the factor.
Respect the Notice of Assignment
Under the Uniform Commercial Code or UCC 9-406(a), once the customer receives the NOA, their obligation is satisfied only when they pay the factor, not you.
If a customer accidentally sends payment to you and you don’t forward it, that customer may legally owe the factor again. This is the law.
Common Real-World Scenario
A customer has paid your factoring company for months or even years. Suddenly, a payment shows up in your account. Hopefully, you’ll immediately recognize that that payment should have gone to your factoring company.
Why? Often a large company’s vendor system doesn’t update across departments or
accounting systems are changed or a vendor management system is installed.
The correct response:
- Notify your factor IMMEDIATELY.
- Share remittance details.
- Forward the funds.
HANDLED PROMPTLY, IT’S NO ISSUE. Factors recognize despite their best efforts and absent willful re-direction it happens. Holding payments that belong to your factoring company however, affect your customer as they are not off the hook, you risk paying default fees, your integrity is questioned and can poison the relationship.
4. Understanding Reserve Accounts: Accrued vs. Cash Reserve
Factoring uses two types of reserve accounts and it may initially be a bit confusing if you’re not an accountant.
1. Accrued Reserve (“On Paper”)
This is the portion of the invoice not advanced upfront. It’s a bookkeeping entry, not actual cash. This is representing what will be returned to you after your customer pays.
2. Cash Reserve (“Real Money”)
This is the actual cash balance available once your customer pays the invoice and the factor deducts its discount fee.
Side-by-Side Example
Accrued Reserve Example Cash Reserve Example
Invoice Value: $10,000 Payment Received: $10,000
Advance Rate: 85% Advance Repaid: $8,500
Funding to Client: $8,500 Factor’s Discount: $200
Accrued Reserve: $1,500 Cash Due Client: $1,300
Why Reserves Matter
The reserve keeps the account within formula, meaning the total funds employed to a client should never exceed the approved advance rate.
Most factors release reserves weekly, but may release early during heavy collection weeks, lots of non-factored collected or should an accommodation be needed. Cash Reserves may be held if disputes, potential chargebacks, or slow-paying customers create uncertainty.
Your Customer Choices Affect Cash Flow
Factoring accelerates payment; it can’t change customer behavior.
Payments from strong and reliable customers equals:
- Quicker & reliable reserve releases
- Smoother funding
- Fewer credit issues
Payments from slow-paying customers can create:
- Tighter credit limits
- Delayed reserve releases
- Inconsistent cash flow
Pick customers wisely.
5. Verification of Invoices: Why Factors Contact Your Customers
Verification is one of the most misunderstood parts of factoring.
Factors depend on third parties (your customers) to pay invoices, so they must verify accuracy before advancing funds. But good factors do it professionally, unobtrusively and with a little of your assistance, often transparently.
Ways Invoices Are Verified
1. Phone Calls (Often made on your behalf)
Many factors call customers without identifying themselves as the factor, simply confirming invoices on your behalf.
2. Support Documentation
Clean, complete paperwork (contracts, POs, change orders, signed delivery receipts,
timesheets, PODs, etc.) can dramatically reduce the need for direct verification.
3. Written Confirmation
Email is fast, clear, and provides written documentation of results.
4. Online Vendor Portals
Large customers often have portals where open invoices can be viewed and verified.
Why Verification Helps You
It’s more than checking boxes, it’s an early warning system. During verification, factors often learn:
- A customer is disputing an invoice, goods or services,
- A P.O. isn’t correct,
- A delivery was incomplete or damaged
- A billing address changed,
- Payment is in transit
Catching issues early protects your cash flow.
6. Invoice Monitoring & Collections: Light- Touch, Not Aggressive
Factoring companies are not collection agencies.
Factoring Companies buy performing invoices and expect them to be paid within terms. The best results come when you factor your best-paying customers, not problem accounts.
Why Use Your Best Payers?
The Advance is the same whether an invoice pays in 40 or 70 days. But:
Slow payers → more risk → tighter credit → slower reserves → higher fees
Fast payers → confidence → higher advances → quicker reserves → better pricing
How Factors Monitor Invoices
After funding, the factor:
- Tracks and builds payment patterns in their software,
- Builds rapport with your customers A/P department
- Creates internal reminders which correspond with those customers normal payment days
- Contacts customers when payments drift past expected dates using a light touch
- Alerts you immediately to any disputes or delays
Most factors prefer you to stay involved in customer relationships. They step in only when needed and often communicate on your behalf for consistency. Teamwork is necessary and critical to keep invoices paying in their normal course of business.
Their goal is simple:
Keep your customer relationships intact while keeping payments on track.
7. Submitting Invoices for Funding: How to Get Paid Fast
Factoring shouldn’t disrupt your workflow. You continue invoicing customers the same way, you simply send copies and supporting documents to your factor when you want to get funded.
- Invoice immediately after goods are delivered or work is complete,
- Follow customer billing instructions exactly,
- Confirm they received the invoice,
- Double-check accuracy (PO, quantity, rates, signatures, dates).
- CC or BCC the factoring company on invoice emails for transparency.
- Submit in batches, single PDFs, portal uploads, or through an app.
Most factors fund within 24 hours of receiving complete invoices. Some even offer same-day funding.
You Control the Discount Fees You Pay
Fees typically begin when the advance is made, not when the invoice is created, giving you some flexibility in timing submissions. This timing can affect how much you pay.
When done right, factoring becomes a behind-the-scenes engine that fuels your cash flow without interrupting how you run your business.
Final Thoughts
Factoring works best when you understand how each part of the back-office process affects your cash flow. Strong customer credit, clean invoicing, accurate documentation, and transparent communication all contribute to:
- Faster funding
- Predictable reserve releases
- Higher advance rates
- Lower fees
- A stress-free factoring experience
A great factoring partner should feel like an extension of your financial team, helping you grow, smoothing out cash flow, and protecting your business from bad debt.
FAQ: Invoice Factoring – Customer Credit, Payments, Reserves, Verification & Funding
Customer credit is the foundation of every factoring decision. Factors evaluate your customers, not your business to determine whether invoices are eligible for funding, how much they’ll advance, and what credit limits they’ll assign. Strong customer payment histories lead to higher limits, smoother funding, and faster reserve releases.
Factoring credit limits are based on third-party data, verified payment trends, and real-time risk indicators from commercial credit bureaus. These limits may differ from what you’re comfortable extending because the factor is advancing cash before the customer pays. As customers prove consistent payment performance, limits typically increase.
Under UCC 9-406(a), once a Notice of Assignment has been sent, your customer is legally required to pay the factoring company. If a payment comes to you by mistake, simply notify your factor and forward the funds immediately. Handled quickly, it’s not an issue. Keeping the payment, however, can create fees, trust problems, and even legal exposure for your customer.
Because factoring isn’t a loan. The factor is repaid directly by your customers. A Notice of Assignment ensures payments flow to the correct place and protects both you and the factor from misdirected funds.
There are two types of reserves:
- Accrued Reserve – The portion of the invoice not advanced upfront (an accounting entry).
- Cash Reserve – The actual money released once the customer pays the invoice, less the factoring fee.
Reserves help keep your account “within formula,” ensuring cash employed to you never exceeds the approved advance rate.
Most factoring companies release reserves weekly, though some may release funds earlier after large collection weeks. Delays typically occur when there are disputes, chargebacks, or slow-paying customers that introduce risk.
Not always, but some level of verification is almost always part of the process. Verification can be done through documentation review, phone calls made as your company, written confirmations, vendor portals, or a combination. Clean, complete supporting paperwork reduces the need for outside verification.
No, especially when verification and communication are handled professionally. Most large companies are familiar with factoring. In many industries (temporary staffing, transportation, manufacturing), factoring is simply a normal part of doing business and improving cash flow.
Not at all. Factoring companies only buy performing invoices expected to be paid on time. They do not chase delinquent customers or pressure good paying ones. Their communication is light, professional, and focused on verifying payment status, not collecting debt.
Because factoring advances the same amount whether the invoice pays in 40 or 70 days but the risk and timing change dramatically. Strong payers lead to predictable cash flow, faster reserves, better advance rates, and lower fees. Slow payers create delays and can increase your cost of capital.
Most factors fund within 24 hours of receiving complete invoices, supporting documents and meet their verification thresholds. Same-day funding is sometimes available. Accuracy and complete documentation are the biggest drivers of speed.
This varies by industry, but typically includes:
- The invoice
- Contract, purchase order, rate confirmation, or timesheet
- Signed delivery documents or proof of service
Providing complete documentation reduces verification time and speeds up funding.
Generally, no. You continue invoicing customers the same way you always have. Some industries, specifically transportation factors generate and send invoices as a value-added service.
It’s up to you and depends on your cash needs. Some clients submit daily, others weekly. Discount fees usually start when you receive funds, not when you create the invoice, giving you some flexibility in timing which helps control the discount fees.
Your factor will notify you immediately or if you find out, you have a duty to inform your factoring company. Since disputes affect collectability, the factor may temporarily hold reserves or pause additional funding from that customer until the issue is resolved. Once resolved, funding returns to normal.
Yes, and many businesses overlook this advantage. Factors review thousands of companies across industries and offer valuable insight about customer creditworthiness, payment behavior, contract terms, and risk signals. It’s like having a built-in credit department.
Common causes include:
- Missing or incomplete documentation
- Customer disputes
- Slow-paying customers
- No verification
- Aging invoices hitting thresholds
- Exceeding customer-specific credit limits
- Poor customer communication
- Pending chargebacks
Most delays are easily avoided with clean invoicing and timely communication.
No. Factoring accelerates cash flow for you, but it does not change your customers’ payment speed. Slow payers will still pay slowly, the factor simply manages the timing and risk.
Submit clean, accurate invoices with complete documentation. When everything matches the PO or contract, the factor has less need to verify.
A few simple habits make a big difference:
- Invoice accurately and promptly
- Provide complete supporting documents
- Respond quickly to questions
- Problems arise in the normal course of any business, remain transparent
- Keep your factor updated on issues or customer changes
- Use their credit tools before onboarding new customers
The best factoring relationships feel like an extension of your financial team.
Marc Marin is a seasoned expert in business financing, author, speaker, and educator with over 20 years of experience helping companies access working capital through factoring and funding solutions. He is known for making complex financial topics clear and actionable for business owners and finance professionals.