Factoring Companies; Accounts Receivable Factoring; Factoring

Factoring companies are in the business of financing short-term needs of companies.  Factoring companies purchase the accounts receivable of companies looking for short terms financing.  They purchase invoices or more precisely accounts receivable at a significant discount.  For example, a factor might purchase the right to receive payment against a creditor company's invoice for $1,000 for $950.  The $50 represents their profit, but out of that $50 they must consider the time value of money.  For example, if the factor expects to receive payment in 3 days from the debtor to whom the product was shipped, purchasing the accounts receivable at a 5% discount would be far more attractive than purchasing A/R that is not due and payable from the debtor company for 33 days.

Many factors or factoring companies are owned directly or indirectly by banks. Factoring is a process in which a factoring company purchases a debt or invoice from another company.  The accounts receivable purchased by a factoring company is bought at a discount.  This allows the buyer, meaning the factoring company, to make a profit when the accounts receivable is collected. 

The big difference between factoring companies and finance companies is that factors often purchase accounts receivable without recourse as opposed to lending money secured by the receivable.  The term without recourse means that the seller/creditor is paid by the factor irrespective of whether the factor is able to collect from the buyer.  Knowing whether any financing arrangement is with recourse or alternatively without recourse is critical to the credit manager and his or her understanding of the credit risk associated with making a sale.

Edited by Michael C. Dennis, author of "The Credit and Collection Manager's Concise Desk Reference."