Factoring is a financial transaction where a business sells its accounts receivables or invoices to a third party at a discount. This allows the business to access cash from their outstanding invoices immediately rather than waiting 30, 60, or 90 days for clients to pay. A factoring company, often called a factor, purchases the rights to the invoices and handles the billing and collection on behalf of the client company.

The Types of Factoring

There are two main types of factoring arrangements:

Recourse Factoring: With recourse Factoring Services, the client company remains responsible if the customer does not pay the purchased invoices. The factor has the right to collect unpaid invoices from the client company.

Non-Recourse Factoring: With non-recourse factoring, the factor assumes all responsibility and risk if a customer does not pay a purchased invoice. The client company is not obligated to buy back or pay for unpaid invoices. This provides more security but usually comes at a higher fee compared to recourse factoring.

How Factoring Works

Here are the typical steps involved in a factoring transaction:

1. The business delivers purchased goods or services to its customers and generates invoices for them.

2. The business submits unpaid customer invoices to the factoring company for approval and purchase. The factor reviews the invoices for creditworthiness.

3. If approved, the factoring company sends payment to the business for the purchased invoices, less the factoring fee which is usually 1-5% of the invoice amount.

4. The factor then takes responsibility for collecting payment from the customers and handles all billing and collections going forward.

5. When customers pay their invoices, the money goes to the factoring company. The business arrangement is then complete.

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