Basic Information About Accounts Receivable Factoring

In general business terms, accounts receivable refers to money that is owed to a business by its clients or customers. It is shown on a balance sheet as an asset.

In the world of factoring, accounts receivable commonly refers to commercial trade debt with a maturity of less than 90 days. In some cases, that number stretches to 120 days, but it is always on a short-term basis. A ‘factor’ might hear offers to buy debt that extends over a longer term, but those types of deals go against the true meaning of the process.

What Is A/R Factoring?

Accounts receivable factoring, also known as accounts receivable ‘financing’ is a situation where a business will sell its accounts receivable to a third party, known as a ‘factor’. The accounts receivable are sold for a price that’s lower than the total of the account.

The factors that purchase the accounts receivable get to keep the balance once the account is paid, and will charge fees to make it a worthwhile business transaction all around.

Common Terms

Some of the common terms used in accounts receivable factoring include:

• Clients or Sellers - these are the companies that sell their receivables.• Customers or Account Debtors - these are the client’s customers that actually owe the money. • Advance - the cash sent to a client as the initial payment for a factored invoice.• Schedule or Assignment or Transaction - when a factor accepts accounts receivable invoices for purchase.

Why Factoring?

The main reason that accounts receivable factoring takes place is to allow the company that is selling the accounts to free up cash. Creating a cash balance will enable them to keep operating and doing business while the accounts receivable are still outstanding.

Whatever the reason for needing the money, factoring can make it happen. It is an age-old business practice that scores of businesses use on a regular basis to help keep the business flow moving forward.

Isn’t It Just a Loan?

Although it seems a lot like a standard loan, factoring and bank loans differ in a few key areas.

• Companies can often get money from a factor when a bank would refuse to provide a loan. • Factors take a look at the businesses that owe the accounts receivable, where a bank will just look at the credit rating of the company needing the loan. • A factor will usually buy the accounts if they feel they will be paid in full, regardless of whether or not the client company continues to make money.

A/R Factoring vs. A/R Lending

Sometimes, A/R Factoring and A/R Lending are mistaken for one another, but there are some important differences to keep in mind.

• A factor takes title to the invoices immediately, while a lender never does, unless the borrower defaults. • A factor’s purchase includes the right to deal directly with the account debtor, while a lender doesn’t have the same right. • A factor tracks the status of each individual invoice, while a lender does not.

What Is Important to a Factor?

When a company is considering taking on accounts receivable as a factor, they look for things like:

• Are the invoices collectable?• Could any outside entities interfere in the process?• What is the back-up plan for collection if it doesn’t work out?

Good factors will conduct an in-depth analysis of the client and their accounts before agreeing to the purchase.

Common Types of Factoring

The most common form of accounts receivable factoring is known as ‘advance factoring’. With this method, a cash advance is paid to the client by the factor before the actual invoiced have been paid. Once they are paid, the client is paid the balance, minus fees and commissions.

Maturity factoring is another form, where no advance is paid to the client. The purchase price of the accounts is paid around the average maturity date of the accounts that have been purchased.

References

http://www.ebf.ca/

The EBF Group Limited