Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. In “advance” factoring, the factor provides financing to the seller of the accounts in the form of a cash “advance,” often 70-85% of the purchase price of the accounts, with the balance of the purchase price being paid, net of the factor’s discount fee (commission) and other charges, upon collection.
In “maturity” factoring, the factor makes no advance on the purchased accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being purchased in the batch. Factoring differs from a bank loan in several ways.
The emphasis is on the value of the receivables (essentially a financial asset), whereas a bank focuses more on the value of the borrower’s total assets, and often considers, in underwriting the loan, the value attributable to non-accounts collateral owned by the borrower also, such as inventory, equipment, and real property, i.e., matters beyond the credit worthiness of the firm’s accounts receivables and of the account debtors (obligors) thereon. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Third, a nonrecourse factor assumes the “credit risk”, that a purchased account will not collect due solely to the financial inability of account debtor to pay.
In the United States, if the factor does not assume credit risk on the purchased accounts, in most cases a court will recharacterize the transaction as a secured loan.
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