Factoring Accounts Receivable, Debt & Invoices

Factoring is a financial transaction in which a business sells its accounts receivable to a third party at a discounted rate. In some cases, the factor (third party) provides financing to the seller as a cash advance – generally 70 to 80 percent of the purchase price of the accounts.

Factoring vs. Bank Loan

Although you may believe that a bank loan is your best option, it is important to compare this to factoring. The main differences include:

• Higher value placed on the receivables as opposed to the borrower’s assets and credit score/history
• This is not a loan, but instead the purchase of a financial asset.

If you are interested in factoring, there are three main players in any transaction:

• The person or organization who is selling the receivable
• The factor
• The customer of the seller, also known as the account debtor

Reason for Factoring

Most organizations rely on factoring as a method of obtaining cash. For example, accounts can be factored when the available cash balance is unable to meet current financial obligations.

In some industries, though, factoring is common as this is the financing method that has always been used. Textiles and apparel are two industries in which factoring is a traditional method of financing. 

Debt factoring is also used to increase cash flow, especially if an organization has many receivables with varying credit terms. By selling invoices at a discount it is better for the company to use the cash to funds its growth than to act as their “customer’s lender.”

Common Types of Factoring

There are several types of factoring including:

• Commercial receivable factoring
• Credit card factoring
• Debt factoring
• Invoice factoring
• Accounts receivable factoring

Factoring Risks

Although there are many benefits of factoring, you must also be aware of the potential risks:

• External fraud by clients
• Tax risks
• ICT risks

History shows that factoring has been a common business practice since the 1400’s. With a variety of benefits, this financial strategy will continue to be used for many years to come.