You must have come across lots of concepts or conviction through which on can get funding or inject cash in their Business. This Blog is merely to highlight the attribute of Factoring Companies and the way they are accounted.

For those who are now thinking, what is Factoring or a Factoring company? Let me bring up to you,

Factoring is a mechanism for businesses to inject cash into their accounts by selling their invoices to a third party at a discount. Factoring company provides financing to companies that have cash flow problems due to slow-paying invoices.  The process goes hand in hand, as factors purchase accounts receivable from their clients at a small discount. The client gets immediate funds from the sale of their receivables, which solves their financial problems. The factor, who now holds the receivables, waits until the invoices get paid on their usual terms.

Most factoring lines don’t work like loans and are much easier to obtain. Financing lines are used by small to midsize companies that need to improve their cash position.

Factoring companies are not one-size-fits-all. In fact, many focus on specific industries like trucking, construction or staffing. Some banks offer factoring services, but the majority of factoring companies are independent providers.

Factoring transactions are straightforward and easy to use. In most cases, the factoring company buys the receivable in two installment payments; the first installment usually called as advance, generally covers 80% to 90% of the invoice, which can vary based on the risk profile of the transaction. The remaining 10% to 20% of the invoice, less a small factoring fee, is advanced as a second installment once the end client pays the invoice in full. This payment settles the transaction.

Factoring may not make sense if you as a business owner have good credit, a low debt-to-income ratio, and you don’t need the cash within a week. In this case, a long-term business loan or line of credit would be a better fit because the effective interest rate will be much lower.

To further elaborate, Factoring companies usually offer one of two types of factoring:

  1. Recourse Factoring
  2. Non- recourse Factoring

Unfortunately, the subject of “recourse” is one of the most misunderstood concepts in the industry. In a recourse factoring plan, your company is always responsible if your client does not pay. After 90 days, the factoring company can present an unpaid invoice to you for reimbursement.

Whereas, in a non-recourse plan, you don’t have to pay the factor back if the client does not pay due to bankruptcy. However, the bankruptcy usually needs to happen during the first 90 days that the invoice is outstanding. Bankruptcies after this 90-day period are often not covered. This important detail is often overlooked by clients. Note that non-recourse factoring does not protect you against late client payments. Invoices that remain unpaid after 90 days are still returned to you for reimbursement, regardless of recourse. Nor it is not necessarily better for your company. While non-recourse offers some protection against client bankruptcies, it comes at a price. Non-recourse plans tend to be more expensive and restrictive.

One might think, how do such companies charge their customers? Or what is their profit making point.

The Charge majorly depends on three aspects:

  • The Amount of Money Being Factored
  • The Length of Your Invoice Terms
  • The Credit Quality of Your Customer

A factoring company charges the business client a factor fee, which is the fee they charge for the advancement of funds. A good way to think of this fee is as a discount rate. For example, if the factor fee is 1% on a $30,000 invoice, then the fee is $300. Keep in mind, the 1% rate in this example is likely to grow to 2% on a weekly basis, and by the third month, expect 5%.

Factor fees often scale from 0.75% to 5%. The longer it takes your customer to pay off the invoice in full to the factoring company, the higher the factor rate climbs over time.

The cost of factoring is determined by your financing volume and the credit quality of your invoices. In general, fees range from 1.15% to 3.5% per month.

Fees can be structured to suit your needs. Some situations call for flat fee structures, while others use a pro-rated model. Fees can be negotiated with the factoring company and vary by client.

The accounting for such factoring transactions can be bit tricky. Getting the light onto the accounting procedure followed:

When a business sells invoices with recourse, the factoring company can collect if the invoices are unpaid. During the negotiations, the seller estimates the potential loss and records the recourse liability. Therefore, the factoring transactions require several entries.

  • Record a credit in accounts receivable for the sold invoices.
  • Record a credit in recourse liability after estimating the bad debts and potential loss.
  • Record the cash received as a debit in the cash account.
  • Record the factoring fee and the estimated bad debts as a debit loss.
  • Record the amount the factoring company retained in the debit-due account.

If the debts remain unpaid, the factoring company can ask the business to pay the difference.

Unpaid debts need to be recorded. First, you post a credit due from the factor in the amount retained. Then, find the difference between the retainer and the bad debts before debiting that amount in the cash account. Finally, you record the estimated bad debts as a debit in the recourse liability account.

When a business sells invoices without recourse, they record the factoring transaction in the journal as:.

  • Record the amount sold as a credit in accounts receivable.
  • Record the cash received as a debit in the cash account.
  • Record the paid factoring fee as a debit loss.
  • Record the amount the factoring company retained in the debit-due account.

If the factoring company receives some of the unpaid debt without exceeding the retained amount, the factor will repay a portion of the retainer. You can record the transaction by crediting the due account with the retained amount, then debit allowance for the uncollected amount. Finally, debit the cash account for the amount retained less the unpaid receivables.

The last instance involves the receivables being unpaid. Since the invoices were sold without recourse, the business does not have to pay any losses to the factor. You record this by debiting the allowance account for doubtful accounts and crediting the due account from the factor’s retained amount.

To Sum up this blog, jotting down some tips while choosing best Factoring Company.

A superior factoring company can be picked by giving due respect to certain aspects such as:

  • How long have they been in business?
  • What are their terms, fees and funding limits?
  • How frequently and quickly will your invoices be funded and payments applied?
  • How will they interact with your customers?
  • Where are their funds coming from (are they a bank, or a middleman?)






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