Accounting for Factoring: Principles, Impacts, and Techniques

Since you’re guaranteeing recovery for the invoice, a recourse liability is determined and recorded. When accounts receivable are non-recourse factoring, the factoring company accepts any loss resulting from non-payment. Basically, you’re not obligated to pay the invoice back in the unlikely event that your customer doesn’t pay the invoice. In accounts receivable factoring, a company sells unpaid invoices, or accounts receivable, to a third-party financial company, known as a factor, at a discount for immediate cash.

Factoring receivables with recourse vs non-recourse

It is an attractive option for companies that can afford to wait for payment but seek to enhance their collection efficiency and reduce the risk of late payments. Factoring receivables is a commonly used financial practice that provides businesses with immediate cash by selling their accounts receivable to a third-party company, known as a factor. While factoring offers numerous benefits to businesses, it is important to understand the accounting treatment of factoring receivables to ensure accurate financial record-keeping. A simpler transaction results in less complexity in accounting compared to a traditional loan for example. Factoring receivables is an effective financial solution for businesses needing quick cash.

To meet its short-term cash needs, the Noor company factors $375,000 of accounts receivable with Moto Finance on a without recourse basis. The Moto Finance assesses the quality of accounts receivable and charges a fee of 5%. It also retains an amount equal to 10% of the accounts receivable for probable adjustments against discounts, returns and allowances etc. As the due date approaches, factor meets receivables and collects full amount of cash. The difference between the cash collected from receivables and the cash paid to the seller company forms the profit of the factor.

Accounting Treatment for Factoring Receivables

In a factoring with recourse transaction, the seller guarantees the collection of accounts receivable i.e., if a receivable fails to pay to the factor, the seller will pay. As the recovery is guaranteed by the seller, a recourse liability is determined and recorded by him. The loss on sale of receivable is also increased by the amount of recourse liability. In short, accounts receivable automation software streamlines the entire collections process and accelerates cash flow. In non-recourse factoring, the factor assumes the risk of non-payment by customers and the business selling their invoices won’t be liable if their customers fail to pay.

• Factoring, a financial transaction where businesses sell their accounts receivable to third parties at a discount, has become an essential tool for managing cash flow and mitigating credit risk.
• Small business owners have more forms of financing available to them than ever before, including invoice factoring, also sometimes known as factoring receivables.
• With non-recourse factoring, the factor assumes the risk of non-payment due to customer insolvency.
• By following these steps, businesses can effectively manage their factoring receivables.
• Factoring or discounting of account receivables is common for new and small businesses with a high collection rate but less access to credit facilities.
• The higher cash received can be highly valuable for some businesses, especially ones going through cash flow problems.

Finally, most non-recourse factoring options require businesses to sell all of their receivables to the factor. With recourse factoring, businesses get the option to sell only selected receivables to them. This can help the business only outsource recoverability of late-paying invoices and still hold to invoices that they expect to be received soon. The main advantage of factoring is that it can help businesses looking for cash or going through cash flow problems.

The factoring company will charge interest at 10% until the full repayment of the advance. In recourse factoring, a business will agree with the factor, which requires the business to buy back any unpaid receivables from the factor. Therefore, in this type of factoring, the risks of bad debt or default will always exist for the business. The business selling the receivables will always remain liable for the receivables as long as the factor does not receive cash for it for any reason. In case a receivable is not recovered, statement of cash flows: free template andexamples the business either has to pay the factor for the amount of the receivable or pay them with new receivables or invoices. Instead, the amount sold is recorded as a credit in accounts receivable and the cash received is recorded as a debit in the cash account.

How do I find Factoring Companies?

This helps provide a more accurate representation of the company’s receivables and ensures that only collectible amounts are reported on the balance sheet. Upon selling the receivables, the business receives immediate cash from the factor. This ensures that the increase in cash is accurately reflected in the financial records. However, it is important for businesses to accurately record these transactions in their accounting books to ensure transparency and proper financial reporting. When an entity factors its receivables, it must determine whether the transaction qualifies for derecognition of the receivables from its balance sheet. If the transaction meets the criteria for derecognition, the entity should remove the receivables from its balance sheet and recognize a gain or loss on the factoring transaction.

Balance Sheet

When accounts receivable are factored without recourse, the factor (purchasing institution) bears the loss resulting from bad debts. For example, if a receivable whose account has been factored becomes bankrupt and the amount due from him cannot be collected, the factor will have to bear the loss. The discounting of receivables with resources is recorded as short-term debt in accounting books. When the entity recovers the cash from debtors, the short-term debt is written off. Factoring and AR factoring can be valuable tools for businesses needing quick access to cash.

When receivables are sold to a factor, they must be removed from the balance sheet unless the arrangement includes recourse provisions. Just as it’s important to find a factoring company that knows your business, it’s just as important to find one that’s well established and has a reliable track record in the factoring industry. At a minimum, look for a company that is affiliated with the International Factoring Association (IFA).

Your Guide to Accounts Receivable Factoring

With an invoicing software like Hopscotch, you can streamline the accounts receivable process. When you use the Flow feature to advance money from your invoices, you don’t have to track remittance—each step is automatically processed for you as part of the invoice transaction. These solutions automate the most tedious accounts receivable tasks, like printing invoices and stuffing envelopes, to the most complex, like cash application and dispute management. Choosing the right software is an important decision as the right tool is valuable beyond just its features and capabilities; it will actually strengthen customer experience and relationships. Businesses looking to expand into a new location or launch a new product often need additional funding. Factoring accounts receivable can help growing businesses be more flexible and eliminate cash flow concerns.

How to account for a factoring arrangement

The fee and payment structures get complicated, adding to the already complex nature of accounts receivable accounting. While non-recourse factoring might be slightly more accountant partners payroll and hr software difficult to obtain, it is still easy for businesses to obtain it. Compared to other types of finance such as a line of credit or bank loans, non-recourse factoring is much easier to apply for and obtain. As long as the invoices of business are from creditworthy customers, there are no restrictions in getting non-recourse factoring. When a business sells its accounts receivable to a factor, the amount sold must be recorded.

• In some ways, the factoring company acts as your accounts receivable back office.
• Let’s assume that a company, Al-Khair, has decided to factor the account receivables with a factoring company ABC.
• Vivek Shankar specializes in content for fintech and financial services companies.
• It’s easy to see how hidden fees can make the cost of invoice factoring add up over a period of time, making it an important question to ask any factoring company you’re considering.
• Bret Lawrence writes about invoicing and cash flow management at Hopscotch.
• The fee and payment structures get complicated, adding to the already complex nature of accounts receivable accounting.
• However, a considerable percentage of the sales are made on a credit basis.

By outsourcing accounts receivable collections to a factoring company, businesses can reduce the time and resources spent chasing customers for overdue payments. The FastGrowth company factors $375,000 of accounts receivable with Ample Finance on a non-recourse factoring basis. Ample Finance does an assessment and determines a fee (also known as a discount rate) of 5 percent. It advances 90 percent of the invoice, retaining 10 percent of the invoice amount. When FastGrowth’s customer pays the invoice, Ample Finance will remit the 10 percent to FastGrowth, less their 5 percent discount rate.

The factor then assumes responsibility for collecting the outstanding payments from the customers. Accounts receivable factoring deals with the sale of unpaid 11 things to watch out for when buying a leasehold property invoices, whereas accounts receivable financing uses those unpaid invoices as collateral. Borrowers will receive financing based on what their accounts receivable is worth. Then, once the invoices are paid—the collections process in this scenario resides with the seller—the borrower pays the lender back, with fees. Factoring transactions can have significant tax implications that businesses must carefully navigate to ensure compliance and optimize their tax positions. One of the primary considerations is the treatment of the proceeds received from the factor.

These current assets on your balance sheet serve as a key indicator of its financial health and liquidity, directly impacting your operating cycle. Paystand is on a mission to create a more open financial system, starting with B2B payments. Using blockchain and cloud technology, we pioneered Payments-as-a-Service to digitize and automate your entire cash lifecycle. Our software makes it possible to digitize receivables, automate processing, reduce time-to-cash, eliminate transaction fees, and enable new revenue. When you factor in receivables, you’re outsourcing your collections process. Accounts receivable factoring transforms your existing assets into immediate cash without adding debt to your balance sheet.

It’s not just another financing option but a cash flow acceleration strategy that can fundamentally change how your business manages working capital and fuels growth in a competitive marketplace. If you are unsure how to complete these steps in your given accounting software, you can consult with them specifically to ask questions like. ” They may have online tutorials or customer service representatives that can help you.