How to understand invoice factoring

Definition

Invoice factoring is the sale of open customer invoices to a factor. On the books, the accounts receivable comes off, cash comes on, and the factor's fee hits the Income Statement.

You record the sale so the Balance Sheet no longer shows that invoice as yours. The customer now owes the factor, not you.

Cash-basis books still show the cash that arrived from the factor. Accrual books also take the receivable off, which cash-basis books may never have shown.

This event is a sale of invoices, not a loan. There is no new loan for the cash the factor sent.

Where it shows up

Balance Sheet: Related to selling the receivable off the books.

P&L: Related to the discount taken as a fee.

Cash flow: Decreases in receivables, reported cash from operating activities increases.

See also: Accounts Receivable · Days Sales Outstanding · Working Capital

When you look at your Balance Sheet, the invoiced amount that was sold is gone from receivables. You will not find a matching loan for the cash the factor sent, because you did not borrow.

When this activity is high, more invoices have been sold, so receivables look smaller and cash has already arrived. When this activity is low, more invoices are still waiting on customers in the ordinary way.

The profit and loss statement shows the factor's fee, not the full invoice. The fee is the discount; the rest of the invoice was cash and a reduction of the receivable.

On the Statement of Cash Flows, the cash from the factor is operating cash. Receivables went down because you sold them, which is why that cash is reported as operating, like a collection.

Days Sales Outstanding often looks better after a sale, because the slow invoice is no longer yours to collect. Working Capital also changes, because cash replaced a receivable, minus the fee.

How it works

The sale gets onto the books when the factor buys the invoice and sends cash. You debit cash for the proceeds, debit a fee for the discount, and credit the receivable for the full invoice.

That entry does not wait for the customer to pay the factor. The receivable is already gone from your books the day of the sale.

Stay with this sale: it is not Asset-Based Lending. In that other path you keep the invoice and you owe a lender; here you sell the invoice and you do not owe the cash back.

Some contracts let the factor return an unpaid invoice to you, which shops call recourse. If that happens, the receivable can come back on, and you may have to return cash; until then, treat the first entry as a sale.

The factor, not your Collections desk, is who follows up after a true sale. Your job is to stop showing that invoice as yours and to record the fee in the period you sold it.

The fee is a cost of getting cash before the customer would have paid. It hits the P&L as Bank Fees or a similar expense, not as interest on a loan you do not have.

A customer credit check still matters, because the factor is buying the right to collect from that customer. A shop that already sits at a high credit limit with slow payers may find the factor will not buy those invoices.

Reconcile the invoices you sold to the factor's settlement report. A receivable left on the books after a sale will double-count an amount the factor now owns.

Example

A staffing agency invoices a client $12,000 for a week's placements. The same day it sells that invoice to a factor at a 3 percent fee, so cash of $11,640 arrives and the $360 discount is the fee.

The agency records the cash piece:

Debit: Cash $11,640

Credit: Accounts receivable $11,640

It then records the fee piece:

Debit: Bank fees $360

Credit: Accounts receivable $360

Cash is up $11,640, receivables are down $12,000, and the Income Statement holds a $360 fee. The $12,000 invoice is no longer an asset of the agency.

When the client later pays the factor, the agency posts nothing. That collection belongs to the factor, because the invoice was already sold.

Common mix-ups

Invoice factoring is not Asset-Based Lending. Asset-based lending is a loan against invoices you still own; this path sells the invoices, so the receivable leaves and no loan is booked.

This sale is not a Line Of Credit draw. A draw raises a loan balance and leaves the receivable in place; a factoring sale removes the receivable and does not create that loan.

This sale is not ordinary Collections. Collections keep the invoice yours until the customer pays you; after a true sale, the factor is the one waiting on the customer.

Related terms

• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Days Sales Outstanding: The average number of days it takes to collect an invoice.
• Invoice: The document that bills a customer and creates a receivable.
• Cash Flow From Financing: Cash from borrowing, repayment, owner contributions, and distributions.
• Asset-Based Lending: Borrowing secured by receivables, inventory, or equipment rather than general credit.
• Collections: The process of following up on unpaid customer invoices.
• Customer Credit Check: The review of a customer's ability to pay before granting terms.
• Credit Limit: The maximum balance a customer is allowed to carry on account.
• Working Capital: Current assets minus current liabilities, showing short-term operating cushion.
• Bank Fees: Charges the bank deducts for account services and transactions.