Accounts Receivable Factoring

What Is Accounts Receivable Factoring?

Accounts receivable factoring involves selling unpaid invoices to a third party to gain immediate cash flow. This allows businesses to receive funds quickly instead of waiting for customer payments.Types of Accounts Receivable Factoring

Recourse vs. Non-Recourse:
- Recourse: The business is liable if the customer doesn't pay.
- Non-Recourse: The factor assumes the risk of non-payment.
Notification vs. Non-Notification:
- Notification: Customers are informed of the factoring arrangement.
- Non-Notification: Customers remain unaware of the factoring deal.
Regular vs. Spot:
- Regular: Ongoing factoring of multiple invoices.
- Spot: One-time factoring of a single invoice.

How Is Accounts Receivable Factoring Calculated?

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Calculate factoring by determining the advance rate (typically 80-90% of the invoice) and subtracting any fees, such as discount and service charges:

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Factoring Amount=Total Invoice Value×Advance Rate−Factoring Fee

How Do Companies Record Accounts Receivable Factoring?

Recourse Factoring:
- Credit accounts receivable for sold invoices.
- Credit recourse liability for potential losses.
- Debit cash for received funds.
- Debit loss for fees and bad debt estimates.
Non-Recourse Factoring:
- Credit accounts receivable for sold amounts.
- Debit cash for received funds.
- Debit loss for factoring fees.

Why Do Businesses Use Accounts Receivable Factoring?

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Businesses use factoring to obtain immediate cash flow, especially when facing irregular customer payments or needing upfront funds to manage operations or address credit issues.

FAQs

What Are the Advantages of Accounts Receivable Factoring?

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Factoring offers several benefits for businesses. It provides liquidity and enhances cash flow by supplying immediate funds. By partnering with a factoring company, businesses can outsource the management of accounts receivable and, in the case of non-recourse factoring, transfer the risk of default. Additionally, factoring offers alternative and often more flexible financing options compared to traditional credit lines or loans. It also enables businesses to provide customers with more flexible payment terms based on the options available from the factoring company.

What Is the Cost of Accounts Receivable Factoring?

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The cost of factoring depends on various factors such as industry type, customer creditworthiness, invoice payment timelines, and invoice size and volume. Typically, factoring costs range from one to five percent of the invoice value, covering both discount and service fees. Some companies offer discounts for high-volume factoring.Example of Accounts Receivable FactoringConsider a business with an unpaid invoice of ₹10,00,000. A factoring company offers an 80% advance rate with a 2% discount fee and a flat service fee of ₹500.

Advance Amount:
Advance=Invoice×0.80=₹10,00,000×0.80=₹8,00,000Advance=Invoice×0.80=₹10,00,000×0.80=₹8,00,000

When the customer pays the invoice, the remaining balance is calculated:

Remaining Balance:
Remaining Balance=₹10,00,000−₹8,00,000=₹2,00,000Remaining Balance=₹10,00,000−₹8,00,000=₹2,00,000
Adjustments:
Adjustments=₹2,00,000−(₹1,600+₹500)=₹1,97,900Adjustments=₹2,00,000−(₹1,600+₹500)=₹1,97,900

The business receives:

Total Received:
₹8,00,000+₹1,97,900=₹9,97,900<₹10,00,000₹8,00,000+₹1,97,900=₹9,97,900<₹10,00,000

The factoring company earns ₹2,100 as compensation for its services.

Difference Between Accounts Receivable Financing and Factoring?

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Accounts receivable factoring is often confused with accounts receivable financing. In financing, a business uses unpaid invoices as collateral for a loan and repays it with proceeds from invoice payments. Unlike factoring, financing is strictly a loan arrangement without the lender's involvement in payment collection from customers.