Factoring

Factoring is the sale of receivables to a third party (the factor) at a discount in exchange for immediate cash. The factor typically advances 70 to 90 percent of invoice face value up front, collects from the customer, and remits the remainder minus fees when the invoice pays. Fees generally run 1 to 5 percent of invoice value depending on volume, customer quality, and how long invoices take to pay. Factoring monetizes the receivable itself, so availability depends on the customers' credit strength more than the seller's, which is why it serves young and fast-growing companies that banks decline.

The recourse distinction is the heart of the deal. In recourse factoring (the common, cheaper form) the seller must buy back invoices the customer fails to pay, so the seller keeps the credit risk and the factor is really providing financing plus collections. In non-recourse factoring the factor absorbs defined credit losses, usually insolvency, and prices accordingly. Related but distinct: invoice discounting and AR-secured borrowing keep the receivables on the seller's books and the collecting in the seller's hands, while true factoring usually involves the factor notifying customers and collecting directly.

Credit managers meet factoring from both sides. As a tool, it trades margin for cash velocity and outsources collections, sensible when growth outruns working capital, expensive as a permanent habit. As a signal, learning that a customer has begun factoring its receivables (visible via UCC filings and notification letters instructing payment to a factor) tells you the customer needed liquidity and its receivables are pledged, both relevant to your own underwriting. Also honor the notice mechanics: once notified to pay the factor, paying the original seller may not discharge the debt.