what is a factor 
a factor is an intermediary agent that provides cash or financing to companies by purchasing their accounts receivables in short a factor is a funding source the factor agrees to pay the company the value of an invoice less a discount for commission and fees factoring can help companies improve their short term cash needs by selling their receivables in return for an injection of cash from the factoring company the practice is also known as factoring factoring finance and accounts receivable financing investopedia sydney burnsunderstanding a factorfactoring allows a business to obtain immediate capital in the amount of the anticipated future income due from all outstanding invoices these invoices are captured in accounts receivable an asset account on a company s balance sheet which represents money owed to the company from customers for sales made on credit for accounting purposes receivables are recorded on the balance sheet as current assets since the money is usually collected in less than one year 1a company can experience cash flow shortfalls when its short term debts or bills exceed the revenue being generated from sales if a company has a significant portion of its sales done via accounts receivables the money collected from the receivables might not be paid in time for the company to meet its short term accounts payable as a result companies can opt to sell their receivables to a factor and receive cash there are three parties directly involved in a transaction involving a factor the first party is the company selling its accounts receivables the second party is the factor that purchases the receivables finally the third party is the company s customer who must now pay the receivable amount to the factor rather than paying the company that was originally owed the money requirements for a factoralthough the terms and conditions set by a factor can vary depending on its internal practices the funds are often released to the seller of the receivables within 24 hours in return for paying the company cash for its accounts receivables the factor earns a fee 1the company selling the receivables transfers the risk of default by its customers to the factor as a result the factor must charge a fee to help compensate for that risk typically a percentage of the receivable amount is kept by the factor however that percentage can vary depending on the creditworthiness of the customers paying the receivables if the financial company acting as the factor believes there s an increased risk of incurring a loss due to the customers not being able to pay the receivable amounts they ll charge a higher fee to the company selling the receivables if there s a low risk from collecting the receivables the factoring fee charged to the company will be lower the duration of time the receivables have been outstanding or uncollected can impact the factoring fee too some financial institutions that provide factoring may have additional terms and conditions for example a factor may want the company to pay additional money in the event one of the company s customers defaults on a receivable 1factoring is not considered a loan because the involved parties neither issue nor acquire debt as part of the transaction the funds provided to the company in exchange for the accounts receivable are also not subject to any restrictions regarding use benefits of a factorthe company selling its receivables gets an immediate cash injection which can help fund its business operations or improve its working capital working capital is vital to companies because it represents the difference between its short term cash inflows such as revenue versus the short term bills or financial obligations such as debt payments selling all or a portion of its accounts receivables to a factor can help prevent a company that s cash strapped from defaulting on its loan payments with a creditor such as a bank although factoring is a relatively expensive form of financing it can help a company improve its cash flow factors provide a valuable service to companies that operate in industries where it takes a long time to convert receivables to cash and to companies that are growing rapidly and need cash to take advantage of new business opportunities 2a financial institution that provides factoring also benefits from these transactions because it can purchase uncollected receivables or assets at a discounted price in exchange for being able to provide cash upfront example of a factorassume a factor has agreed to purchase an invoice of 1 million from clothing manufacturers inc representing outstanding receivables from behemoth co the factor negotiates to discount the invoice by 4 and will advance 720 000 to clothing manufacturers inc the balance of 240 000 will be forwarded by the factor to clothing manufacturers inc upon receipt of the 1 million accounts receivable invoice for behemoth co the factor s fees and commissions from this factoring deal amount to 40 000 the factor is more concerned with the creditworthiness of the invoiced party behemoth co than the company from which it has purchased the receivables 