Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) 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 their receivables to a forfaiter.Please refer to the Wiki article forfaiting for further discussion on cites. 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.
In the United States, Factoring is not the same as invoice discounting (which is called an assignment of accounts receivable in American accounting – as propagated by FASB within GAAP). Factoring is the sale of receivables, whereas invoice discounting ("assignment of accounts receivable" in American accounting) 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. Scottish 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 reviewed this position and made proposals to the Scottish Ministers in 2018.
Overview
There are three parties directly involved: the factor who purchases the receivable, the one who sells the receivable, and the debtor who has a financial liability that requires him or her to make a payment to the owner of the invoice. The receivable, usually associated with an invoice for work performed or goods sold, is essentially a financial asset that gives the owner of the receivable the legal right to collect money from the debtor whose financial liability directly corresponds to the receivable asset.J. Downes, J.E. Goodman, "Dictionary of Finance Investment Terms", Baron's Financial Guides, 2003. Taken from a combination of the definitions of a financial asset and accounts receivable The seller sells the receivables at a discount to the third party, the specialized financial organization (aka the factor) to obtain cash. This process is sometimes used in manufacturing industries when the immediate need for raw material outstrips their available cash and ability to purchase "on account". synonymous with cash flow requirements to meet current liabilities. Citation – Manufacturers' uses of Factoring? Both invoice discounting and factoring are used by B2B companies to ensure they have the immediate cash flow necessary to meet their current and immediate obligations. Invoice factoring is not a relevant financing option for retail or B2C companies because they generally do not have business or commercial clients, a necessary condition for factoring.