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Factoring accounts receivable is when a third party exchanges cash for a business’s uncollected invoices. The third party (called a factor) pays a percentage of the invoice’s face value up-front, allowing the business owner to spend the money rather than wait for it. Factoring accounts receivable is a relatively simple process with relatively easy qualifications. It can often be arranged in days rather than weeks, increasing the flexibility and opportunity of the small business. Collecting on the invoice can be handled in a number of different ways depending on the needs of the business and the terms and conditions of the provider.
There is recourse factoring or non-recourse factoring. In recourse factoring, the seller buys back the account if it has not been paid in a set period of time, typically 90 days. Non-recourse factoring occurs when the factor takes the full risk on the account. This type of deal usually costs more, and the buying companies will usually only buy low-risk accounts. There is also confidential (or invoice) factoring, where the small business collects on the invoice and pays the factor.
One additional benefit of factoring accounts receivable is that it usually puts significantly less stress on the business owner’s personal assets and credit history. Since the factored accounts receivable are the collateral, even individual business owners with very low credit scores can take advantage of such a funding arrangement.