Factoring of accounts receivable
Also known as: receivables factoring, accounts receivable financing
Factoring is the sale of a company's accounts receivable to a third party, called a factor, at a discount. The company receives cash immediately instead of waiting for customers to pay, and the factor earns the difference when it collects the receivables.
Factoring converts money owed by customers into cash today. A company sells its accounts receivable to a factor — often a bank or specialty finance firm — for less than face value. The factor then collects payment directly from the customers and keeps the spread as compensation for its financing and collection services.
Factoring arrangements come in two main forms. In factoring without recourse, the factor assumes the credit risk: if a customer never pays, the loss belongs to the factor, and the receivables are removed from the seller's books as a true sale. In factoring with recourse, the seller must make the factor whole for uncollectible accounts, so the seller retains the credit risk. Factors typically advance a percentage of the receivables up front and hold back a reserve until collections come in.
Companies factor receivables to accelerate cash flow, fund operations without taking on traditional debt, and outsource collections. The trade-off is cost — the discount and fees usually exceed what the company would lose by simply waiting for payment, so factoring is most attractive to businesses that need working capital quickly or have long customer payment cycles.
The CMA Part 1 exam tests factoring within external financial reporting, including the accounting distinction between with-recourse and without-recourse transfers. Note that in algebra, factoring means something entirely different — rewriting a polynomial as a product of simpler expressions — and that meaning is tested on the SAT and CLT math sections.
Key takeaways
- Factoring is selling accounts receivable to a factor at a discount in exchange for immediate cash.
- Without recourse, the factor bears the risk of uncollectible accounts; with recourse, the seller keeps that risk.
- Factors advance cash up front and hold a reserve until customer payments are collected.
- Factoring speeds up cash flow but costs more than waiting for customers to pay.
- CMA Part 1 tests the accounting for factoring, including the with-recourse versus without-recourse distinction.