What is Factoring?

Factoring involves the sale of receivables by a seller to a finance company, which is called the factor. Under a factoring arrangement, the customer is notified that it should now remit payments to the factor. The factor assumes collection risk, while the seller gains immediate access to the cash it needs to run its operations. This is an especially valuable financing option for smaller organizations that do not have ready access to bank loans.

Accounting for a Factoring Arrangement

Essentially, a factoring transaction is recorded as a sale of the receivables, and a gain or loss (usually a loss) is recognized on the receivable transferred to the factor. For example:

Needy Company sells a group of its receivables to Finance Company for $100,000, and receives in exchange $90,000 from Finance Company. The entry is:

	Debit	Credit
Cash	$90,000
Loss on sale of receivables	$10,000
Accounts receivable		$100,000

However, the "loss on sale of receivables" is not really a loss - it is a combination of interest expense related to the early receipt of cash, and the shifting of the risk of bad debt loss to the factor, so a more precise entry of the same transaction might be (assuming a $2,000 factoring fee to cover the risk of bad debt losses):