Factoring

Factoring, sometimes called transaction factoring, is a financial arrangement involving a company with outstanding invoices and a third-party financial institution, known as a factor. The company sells its accounts receivable to the factor at a discounted rate. That way, the business maintains cash flow without having to wait for slow poke customers to pay their bills.

The factor purchases the transactions outright for less than value, then collects payment directly from each customer. Once an invoice’s value has been recovered the original merchant will receive the difference between the discounted price and the invoice amount, minus a fee.

Note that these are not late or uncollectible invoices. While there are similarities, factoring companies are not the same as collection agencies, which deal with overdue accounts, charge a higher fee, and give the merchant nothing until the invoice is collected.

With factoring, it’s generally understood that a company will buy back its invoices once the funds have been collected. Until that point, however, the invoices legally belong to the factor. If the payment cannot be collected for some reason, the factoring company must accept the loss.