Receivables Factoring Explained

Accounts Receivable Factoring is when a business sells unpaid accounts receivable invoices to a specialized financial institution called a Factor. The factoring company buys the invoice from the business for an amount less than its actual face value, then later collects the full amount of the invoice from the account debtor when it finally comes due. This service is useful to a business that cannot afford to wait 30, 60, or 90 days to collect payment from customers, cash is needed immediately for growth or survival.

When a business delivers goods or services to another business, an invoice is generated stating the amount owed and the terms (number of days) in which the invoice must be paid. This invoice along with its terms becomes an accounts receivable. Money owed to a business, from a business, for goods or services delivered are receiveables. The terms for these invoices are usually 30, 60, or even 90 days. After the business sends out the invoice it must wait the length of the term (or longer) to collect the debt and recognize the revenue generated. Waiting for these long billing cycles to close can be difficult for a company that is growing fast or just struggling to survive. Service industries benefit by factoring receivables. Doctors will factor receivables and replace billing systems, and staffing companies are most receptive to factor receivables.

Rather than waiting for long billing cycles to close, a business has the option to sell some or all of its outstanding invoices to a Factor (for a discount) and receive funding within 24 hours or less. The Factor will eventually collect the full amount of the invoice from the account debtor.

The funding from the Factor happens in two parts. 1) The business will receive an advance between 70% and 90% of the invoice amount sold to the Factor. 2) When the Factor collects the full amount of the invoice from the account debtor, the business will receive the remainder of the advance minus the factoring fee.

Factoring receivables is a widely accepted form of financing. Although largely unknown, the Factoring industry is quite large (with over $200 billion factored in 2001) and has been used as a financial service by multi-billion dollar corporations for many years. Only over the last several years has this service been made available to small and medium sized business as an alternative to traditional bank financing. . In recent years it's preferable to factor receivables rather than borrow from ordinary banks, which generally requires at least two years in business with a profit, leinable assets and personal guarantees.

Many new and growing companies have trouble receiving traditional bank financing due to profitability, years in business, and financial strength. Factoring allows these companies to take advantage of their outstanding invoices to raise cash without incurring any additional debt. Factoring is not a loan!