Factoring or receivables financing is a process in which a commercial finance company (factor) purchases a company's receivables at a discount and takes responsibility for collecting the payments due. This enables the company selling the receivables to have access to cash sooner than the usual terms of payment.
In factoring, there are three parties that are involved: the factoring company, the factoring client, and the account debtor (the company that will pay the invoice).
Factoring is based on the creditworthiness of the account debtors. The factoring company will use commercial credit resources to establish the amount of credit they will extend to each account debtor.
The factoring company relies on receiving payment on each invoice directly from the account debtor, which is different from a bank loan.
Recourse vs. Non-Recourse
Factoring is provided on either a recourse or non-recourse basis. In recourse factoring, the company selling its receivables is responsible for payment on each invoice sold to the factoring company if the account debtor does not pay within a specified period of time.
In non-recourse factoring, the factoring company is accepting the risk that the account debtor is unable to pay an invoice. They are not, however, accepting any other risk of non-payment, such as fraud, non-payment due to unacceptable goods, or for any other reason.
Factoring companies typically have 60 to 90 day recourse.
Notification vs. Non-Notification
Traditional factoring is done on a notification basis. This means that the factoring company will send a notice of assignment to account debtors, informing them that the invoices that are factored, have been sold and assigned to the factoring company.
Non-notification factoring the factoring company does not notify the account debtor that the invoices have been factored, they simply have the account debtor change the remittance page.