Factoring Account

As common as the term is, knowledge usage is as rare. Let us see below what it is and how it works.

What is Accounts Receivable Factoring?

Accounts receivable factoring is a method where one company purchases a debt or invoice from another company. In simpler terms, it involves selling your invoices to a third party (called a factor) at a discount, allowing the business to get immediate cash. The factoring company then works to collect the debt.

Most UK businesses have accounts receivable functions. Accounts receivable is the process of generating an invoice for a customer, who must pay it within a set period called credit terms or payment terms.

How Does Accounts Receivable Factoring Work?

When a business sells its invoices to a factoring company:

• The factor advances a percentage of the invoice value upfront.

• Once the customer pays, the factor gives the remaining balance minus their fees.

Factoring transfers ownership of accounts receivable, and the factor is responsible for collecting the payments.

Example: A business with £50,000 in unpaid invoices could sell them to a factor for £48,000 upfront, getting immediate cash to continue operations.

Who Can Benefit from Accounts Receivable Factoring?

Any business that sells goods or services on credit can consider factoring. Small firms often use it to improve cash flow, while large firms may use it to show cash instead of accounts receivable at the end of reporting periods.

Some businesses factor all invoices, while others choose to factor only specific ones. Factoring can be customized to meet the needs of the business.

Factoring vs Traditional Bank Finance

Accounts receivable factoring differs from a bank loan in several ways:

• Focus: Factoring is based on the value of invoices, not the firm’s creditworthiness.

• Not a loan: It is the purchase of invoices, not borrowing money.

• Parties involved: Factoring involves three parties – the seller, the buyer (factor), and the customer – while a bank loan involves two.

Types of Accounts Receivable Factoring

1. Recourse Factoring: The business retains liability if the customer doesn’t pay.

2. Non-Recourse Factoring: The factor assumes the risk of non-payment.

3. Invoice Discounting: The business still collects payments but borrows against invoices.

Advantages of Accounts Receivable Factoring

Factoring companies provide not only funds but also valuable support services:

• Creditworthiness checks for domestic and international customers.

• Maintaining customer payment history (accounts receivable ledger).

• Providing daily management reports on collections.

• Making actual collection calls on behalf of the business.

• Offering an outsourced credit function, helping small firms expand their market.

• Protecting against the financial difficulties of major customers.

• Eliminating the need for permanent skilled staff.

• Helping entrepreneurs avoid liquidity crises and protecting equity.

Summary

Accounts receivable factoring is a flexible financing option that improves cash flow, mitigates risk, and provides additional business support. By choosing the right factoring arrangement, UK businesses can continue operations efficiently while outsourcing invoice collection and credit management.