Invoice Factoring

Accounting for Factoring Receivables: How to Record Factoring Transactions

Accounting for factoring receivables; accounting ledger

Small business owners have more forms of financing available to them than ever before, including invoice factoring, also sometimes known as factoring receivables. Whether you’re new to accounts receivable financing or not, knowing how you should be accounting for factoring receivables in your accounting software is often a pain point for small business owners. This post will give you a complete overview of accounting for factoring receivables, no matter your accounting software. While there are some specifics unique to each program, the general flow is more or less the same. Before we get into the nitty gritty, though, let’s go over a quick explanation of the various aspects of factoring receivables, and what to consider when comparing factoring companies.

What is Factoring Receivables?

Factoring receivables is a creative solution that allows small businesses to turn their unpaid invoices into cash on hand. Oftentimes, B2B companies have large customers who require payment terms of 30, 60, or even 90 days or more. Instead of waiting for weeks or months for your customers to pay their invoices, a factoring company purchases the invoice from you at the full value (minus a fee), giving you cash weeks or even months ahead of the original invoice terms. The invoice company then works directly with your customer to settle the invoice according to the original net terms. This way, you have access to the cash flow you need to take care of any pressing business needs, while your customer benefits from extended payment terms. If you want a more thorough explanation of factoring receivables, see our post, “What Is Invoice Factoring?”

How Factoring Receivables Works

If you want to cover off any short-term cash flow crunches or need funding for growth, a factoring company like FundThrough can help. 

  • First, see if you qualify. Start by setting up a free account. From there, you’ll be able to review available funding options, advance rates, and send in required documentation (business formation documents, government-issued photo ID, a void check).
  • Next, submit your invoices. You can either do this manually, or connect to a supported invoicing software or accounting software – we’re fully integrated with QuickBooks, OpenInvoice, Enverus, and Workbench, for added convenience. Select the invoice you’d like to fund and submit it for review. We’ll then confirm the eligibility of the invoice. 
  • Complete final steps. Once the invoice is deemed eligible, complete any final steps for approval, after which funds are deposited to your account.

If you’re interested in learning more about accounting for factoring receivables, our Complete Guide to Invoice Factoring is chock full of information, and answers 45+ questions you might have about the invoice factoring process.

Advantages of Factoring Receivables

If you’re a small business that wants access to fast and flexible working capital to cover ongoing operational expenses or new expenses, factoring receivables for your business has many benefits. They include: 

  • Provides cash liquidity without the stress of taking on debt or selling equity in your business.
  • Ideal for new businesses. Unless you’ve been in business for a number of years and can prove your profitability, it can be very hard to get funding from a bank or other traditional lender. With accounts receivable factoring that’s not an issue. Because the factoring company is working with your customers, it’s their credit risk and business history that is most important. 
  • Allows you to fund a growth project or opportunity to help scale your business. You can even bid on larger projects when you have fast access to working capital.
  • You no longer have to worry about uneven cash flow, and can better manage your day-to-day operations such as covering payroll or purchasing supplies. It can also help relieve any seasonal strain your business may typically experience, and lets you bolster your books by funding invoices at strategic times. 
  • It’s faster than traditional financing options. Working with a bank or other lender to get access to funds can take weeks or even months, and involve a bunch of paperwork. Business accounts receivable factoring can put money in your account often in a matter of a few business days. (Yes, really!)
  • Accounts receivable factoring also helps reduce admin load. Instead of spending your time tracking and chasing down payments, the factoring company takes care of that hassle for you. This gives you back time to do what you do best – growing and running your business.
  • Most traditional financing solutions require the use of personal assets as collateral, but with accounts receivable factoring, your unpaid invoices are the only collateral. Plus, your personal credit rating or business credit history or credit score isn’t an issue.
  • Accounts receivable factoring provides another source of working capital for your business. You may have a credit card or line of credit, but factoring services complement them by providing additional funds on top of those existing financing options.

Disadvantages of Factoring Receivables

Some potential disadvantages to factoring receivables include:

  • Concern about how a factoring firm will interact with your customers (Read more about how FundThrough works with your customers if you’re wondering about this.)
  • Depending on the invoice financing company, you could be looking at a high factoring fee, hidden fees, or not getting the full invoice total advanced up front.
  • Some invoice factoring companies will make you sign a factoring agreement requiring you to do receivable financing for all your invoices (instead of letting you choose which ones to factor).

Step-by-Step Accounting for Factoring Receivables

The exact steps for accounting for factoring receivables will depend on what specific accounting software you’re using, but the basics are more or less the same no matter what software you’re using. That said, how you account for factored receivables will also depend on whether or not you’re factoring with or without recourse. Each type of factoring process requires different journal entries.

Briefly, factoring with recourse means that the seller of the invoice guarantees the collection of accounts receivable (if your customer fails to pay to the factoring company, you’re on the hook for the invoice.) Since the seller (you) is guaranteeing recovery for the invoice, a recourse liability is determined and recorded by them. When accounts receivable are non-recourse factoring, the factoring company accepts any loss on sale resulting from non-payment. Basically, you’re off the hook in the unlikely event that your customer doesn’t pay the invoice.

How to Record Non-Recourse Factoring Transactions

Let’s look at an example to help understand how accounting for factoring receivables works. 

The FastGrowth company factors $375,000 of accounts receivable with Ample Finance on a non-recourse factoring basis. Ample Finance does an assessment and determines a fee of 5 percent. It also retains an amount equal to 10 percent of the sale of the receivable. 

Both FastGrowth company and Ample Finance will need to make journal entries in their accounting software for the above information, but we’re only going to focus on FastGrowth.

If you’re FastGrowth Company and accounting for factoring receivables without recourse, you’ll make the following journal entries on their balance sheet:

  • Record the amount sold ($375,000) as a credit in accounts receivable.
  • Record the cash received ($318,750) as a debit in the cash account.
  • Record the paid factoring fee ($18,750) as a debit loss.
  • Record the amount the factoring company retained ($37,500) in the debit-due account.

How to Record Invoice Factoring Transactions With Recourse

We’ll continue using the example above. If FastGrowth company estimates that the fair value of the recourse liability is $750, the journal entries to be recorded on their balance sheet are given below:

  • Record a credit in accounts receivable for the sold invoice in the amount of $375,000.
  • Record a credit in recourse liability after estimating the bad debts and potential loss ($750).
  • Record the cash received ($318,750) as a debit in the cash account.
  • Record the factoring fee ($18,750) and the estimated bad debts ($750) as a debit loss.
  • Record the amount the factoring company retained ($37,500) in the debit-due account.

How to Set Up Accounting for Factoring Receivables

Accounting for factoring receivables can be tricky. We’ve broken down the process step by step for recording invoice factoring in your business accounting software. We’ve also included how recording factoring fees works.

Once you’ve received payment for the invoice from the business factoring company

1. Create an account for factored invoices

In your Chart of Account, create a liabilities account just for factored invoices. You’ll use this account for the advances from your factored invoices. You can call it something like, “loan payable – factor”.

2. Create an account for factoring fees

Follow the same steps as above to create an expense account for the factoring fees. You can call it something like, “factor fees”.

3. Create an invoice

Create an invoice just as you normally would.

4. Record a deposit

For the account, choose your liabilities account for factored invoices. Put the invoice number in the description section. In amount, put the full dollar amount of the invoice being factored.

5. Record the fee

Add a line in the same deposit. For the account, choose the expense account for factor fees. In the description amount, put the dollar amount of the invoice times the advance rate. (For example, if you had a $10,000 invoice factored with FundThrough, you’d record this as 10,000 X .025 since our rate is 2.5 percent for a net 30 invoice.) For the amount, enter the fee amount as a negative number. At this point, make sure the net amount matches documentation from the factoring company. Save and close. 

Once the customer payment has been received by the factoring company

6. Record the received payment

Go to Receive Payment. Put in the customer name for the outstanding invoice and the full invoice amount in the amount received. Under “Deposited to” choose “undeposited funds”. Save and close.

7. Apply payment to loan

Go to Bank Deposits. Select the deposit you just recorded. Under “Add funds to this deposit,” choose the liabilities account for factoring you created for the account section (such as “loan payable – factor”). In the amount section, record the full dollar amount of the invoice as a negative number. This will create a net zero deposit that records the loan as paid off. Save and close.

What to Consider When Choosing a Factoring Company

There are a few main things to consider when choosing a factoring company for your business. They include: 

Industry expertise. There’s no shortage of receivable factoring companies out there, but it makes sense to work with one that has experience in your industry. This means the company will already know and understand the unique characteristics of your business – you won’t have to waste time explaining the ins and outs to them. 

Flexibility. Another thing to consider when looking at receivable factoring companies is the amount of flexibility it offers to its clients. Some important questions that can help you determine how flexible a business factoring company is include: How long must I remain in the factoring relationship? Do you require a personal guarantee? Do I have to factor all my invoices? Is there a minimum (or maximum) amount I can factor?

Customer service. A good factoring company is one that’s available to its clients when they need them. Evaluate email and telephone response times during the sales process to get a feel for how a factoring company values its customer service. 

Stability. Just as it’s important to find a factoring company that knows your business, it’s just as  important to find one that’s well established and has a reliable track record in the factoring industry. At a minimum, look for a company that is affiliated with the International Factoring Association (IFA). IFA members must adhere to a strict code of ethics and business practices.  

Cost. Finally, you’ll want to consider the cost of factoring when looking at factoring companies. Don’t forget that depending on the invoice factoring company, you could be looking at a high factoring fee, hidden fees, or not getting the full invoice total advanced up front. Be sure to ask about all potential fees up front so that you can more easily compare your options. 

How Much Does Accounts Receivable Factoring Cost?

The main factor fee is called the discount rate. This is the amount of money that invoice factoring companies withhold from the invoice total as their payment for giving you a cash advance and waiting to get paid for you. You can expect to pay somewhere between 1 and 5 percent. Sometimes, however, factoring companies charge hidden fees on top of this depending on the factoring arrangement. 

The invoice factoring fees you can expect vary between companies and the type of factoring transaction. In addition to the percentage a factor keeps, sometimes there are hidden fees to watch out for:

  • ACH fee. This is the fee for the bank wiring funds to your account, passed on to you from the factoring firm.
  • Application fee. A flat or percentage fee that’s highly variable. 
  • Invoice processing fee. A fee charged for getting your invoices processed in the back office. 
  • Closing fee. An additional amount the invoice financing company keeps from the invoice
  • Monthly fee. If you sign a long-term contract requiring that you sell a certain portion of your invoices each month and you don’t meet the monthly minimums, you could end up paying this fee.
  • Termination fee. Again, this applies if you signed a long-term contract and want to end it early. 

It’s easy to see how hidden fees can make the cost of invoice factoring add up over a period of time, making it an important question to ask any factoring company you’re considering. Here’s where you can find more info about invoice factoring rates.

To give you our perspective, FundThrough’s fees depend on the funding option you choose. Velocity invoice factoring is typically a 2.5 percent to 5 percent factor fee. Our Express invoice financing fee is typically 6 percent. We don’t charge any hidden fees. See our pricing page for more on what you can expect to pay for invoice funding.

Ready to Factor an Invoice?

Get started by creating a free FundThrough account to see if you qualify. Or, connect your QuickBooks, OpenInvoice, or WorkBench account to start funding invoices. Want info about QuickBooks Financing options? Our A-to-Z Guide has you covered!

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