What is factoring?
Factoring is a transaction where a company sells its accounts receivable to a third party commercial financial company (factor). There are up two different methods for setting up factoring transactions:
1. Factoring without recourse is when the rights and the obligations are transferred to the factor the risk on non-payment rest with the factor.
2. Factoring with recourse does not sell the accounts receivable and the risk of non-paying customers remains with the company. This method has lower fees than factoring without recourse.
Factoring companies will purchase invoices and advance funds to companies usually within 24 hours. The advance rate depends on the industry and the company’s customers’ credit histories, but it is typically less than the purchased invoice amounts. Following collection from the company’s customer, the factor pays the company the remaining invoice amounts (reserved balances) minus a fee.
Advantages and disadvantages of factoring
Key advantages include short term solutions to cash inflow. The fees are usually based on the credit worthiness of the company’s accounts receivable (the company’s customers) not the company and the transaction is not secured with the company’s assets.
Key disadvantages are it is not a long term solution; the fees can be substantial; and it can be perceived by creditors and investors as a signal of debt and liquidity problems. It can also require you to contact your Contracting Officer to initiate an assignment of payment to the factor company.
The proper accounting treatment between factoring without recourse and with recourse is particularly important. The IFRS and GAAP both distinguish between two types of factoring methods. Contact us if you have questions or to explore your particular situation.