Factoring
Factoring provides businesses with accounts receivable financing through selling open invoices or selling their open accounts receivable. Thus, financing your business with invoice factoring is a quick and easy way to meet payroll funding without expensive merchant cash advances (MCAs). Even if you were turned down for a business loan or bank line of credit based on your A/R you can turn your invoices into working capital.
Factor financing can also include credit insurance versus buying a policy from insurance companies that offer trade or receivable insurance.
Factoring can help companies improve their short-term cash needs by selling their receivables in return for an injection of cash from the factoring company. The practice is also known as factoring, factoring finance, and accounts receivable financing.
KEY TAKEAWAYS
- A factor is a funding source; it agrees to pay a company the value of an invoice—less a discount for commission and fees.
- The terms and conditions set by a factor may vary depending on its internal practices.
- The factor is more concerned with the creditworthiness of the invoiced party than the company from which it has purchased the receivable.
Understanding a Factor
Factoring allows a business to obtain immediate capital in the amount of the anticipated future income due from all outstanding invoices. These invoices are captured in accounts receivable, an asset account on a company’s balance sheet, which represents money owed to the company from customers for sales made on credit. For accounting purposes, receivables are recorded on the balance sheet as current assets since the money is usually collected in less than one year.1
A company can experience cash flow shortfalls when its short-term debts (or bills) exceed the revenue being generated from sales. If a company has a significant portion of its sales done via accounts receivables, the money collected from the receivables might not be paid in time for the company to meet its short-term accounts payable. As a result, companies can opt to sell their receivables to a factor and receive cash.
There are three parties directly involved in a transaction involving a factor: The first party is the company selling its accounts receivables. The second party is the factor that purchases the receivables. Finally, the third party is the company’s customer, who must now pay the receivable amount to the factor (rather than paying the company that was originally owed the money).