Factoring

Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable to a third party (called a factor) at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell theirreceivables to a forfaiter. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. The Commercial Finance Association is the leading trade association of the asset-based lending and factoring industries. It is Also Covered Under INDAS as same. Factoring is not the same as invoice discounting. Factoring is the sale of receivables, whereas invoice discounting is a borrowing that involves the use of the accounts receivable assets as collateral for the loan. However, in some other markets, such as the UK, invoice discounting is considered to be a form of factoring, involving the “assignment of receivables”, that is included in official factoring statistics. It is therefore also not considered to be borrowing in the UK. In the UK the arrangement is usually confidential in that the debtor is not notified of the assignment of the receivable and the seller of the receivable collects the debt on behalf of the factor. In the UK, the main difference between factoring and invoice discounting is confidentiality. Scots law differs from that of the rest of the UK, in that notification to the account debtor is required for the assignment to take place. The Scottish Law Commission is reviewing this position and seeks to propose reform by the end of 2017.

The factoring process can be broken up into two parts: the initial account setup and ongoing funding. Setting up a factoring account typically takes one to two weeks and involves submitting an application, a list of clients, an accounts receivable aging report and a sample invoice. The approval process involves detailed underwriting, during which time the factoring company can ask for additional documents, such as documents of incorporation, financials, and banks statements. If approved, the business will be set up with a maximum credit line from which they can draw. In the case of notification factoring, the arrangement is not confidential and approval is contingent upon successful notification; a process by which factoring companies send the business’s client or account debtor a Notice of Assignment. The Notice of Assignment serves to

  1. inform debtors that a factoring company is managing all of the business’s receivables,
  2. stake a claim on the financial rights for the receivables factored, and
  3. update the payment address – usually a bank lock box.

Once the account is set up, the business is ready to start funding invoices. Invoices are still approved on an individual basis, but most invoices can be funded in a business day or two, as long as they meet the factor’s criteria. Receivables are funded in two parts. The first part is the “advance” and covers 80% to 85% of the invoice value. This is deposited directly to the business’s bank account. The remaining 15% to 20% is rebated, less the factoring fees, as soon as the invoice is paid in full to the factoring company.