factoring

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Factoring is a type of financing agreement where a creditor buys the rights to or the credit risk of a company’s accounts receivable. Instead of getting a loan from a bank, a company may sell their accounts receivable to a creditor for a fee instead to shore up immediate cash or improve their balance sheets. Factors, when buying accounts receivable, typically acquire all the risk and responsibilities in collecting the future receivables, and factors typically have no recourse to the company. Thus, the company can get cash without worrying about any future liabilities unlike with a loan. However, factors often will ensure that the company retains liability for any breaches of contract or disputes between the company and customers arising before the factoring agreement. 

Instead of buying accounts receivable, sometimes factoring involves a company selling the risk of receivables to a creditor. In this case, the factoring agreement is structured so that the factor has payment obligations only if the company cannot recover the receivables. A company may do this in order to improve their credit and risk exposures. 

Factoring agreements can differ on many levels. For example, the factor and company may negotiate a guarantee from the company or parent which may give the factor a recourse to the company. Factors may benefit from a factoring agreement either through receiving fees or buying receivables at a discount. Also, a factoring agreement may be negotiated for expected future incomes that do not fall under accounts receivable. 

[Last updated in March of 2023 by the Wex Definitions Team]