Factoring receivables is a process by which companies that do not want to manage or collect their account receivable balances can sell their balances at a discount for cash.
Accounts receivable (A/R) factoring is a tool used by businesses to gain quick access to cash without obtaining a loan or selling major parts of the company. A/R factoring is not turning over customers accounts to a collection company; factoring companies usually accept receivables that are in good standing with the selling company. Factoring receivables allows businesses to focus on their operations rather than spending large amounts of time collecting money from past jobs.
Factoring companies purchase business receivables at a discount for cash. Factoring purchase amounts are usually from 75 to 90 percent of the total value of the receivables, and factoring companies require that purchased receivables be less than 90 days old.
Other requirements may be necessary depending on the factoring company and the factoring agreement. Customer credit worthiness, monthly volume and the industry will affect the receivables purchase amount and associated fees.
Non-recourse factoring is where the selling company is not liable for receivables that customers do not pay to the factoring company. Credit worthiness and receivable age are critical requirements for non-recourse factoring.
Recourse factoring requires the selling company to take responsibility for unpaid receivable balances. While the factoring agreement is usually less stringent on requirements, fees and discounts off the receivable amount will still be paid by the selling company.
Balance Sheet Effects
Since factoring is not a loan, no liability will appear on the balance sheet for the selling company. The receivables are removed from the seller’s balance sheet, with an increase to cash from the sold receivables. Records of sold receivables will need to be kept on file, and generally accepted accounting principles (GAAP) must be followed when reporting information or disclosures on the balance sheet.
Questions About Factoring
Before deciding to factor receivables for cash, companies should review the process closely. Questions to ask include:
Will the factoring fees and discounts be worth selling the receivables? Is factoring a one-time process or will it be recurring? Will the cash received be used for business reinvestment or for normal operations?
Factoring receivables can be a great option for quick cash flow if a business is rapidly growing and time spent collecting receivables will hamper growth opportunities.