In today’s dynamic business landscape, small business owners have more financing options than ever before. Among these, accounts receivable (AR) factoring—also known as factoring receivables—stands out as a popular and effective way to manage cash flow. Whether you’re new to AR factoring or looking to refine your understanding, this comprehensive guide will walk you through everything you need to know about AR factoring accounting.
What Is AR Factoring?
AR factoring is a financing solution that allows businesses to convert their unpaid invoices into immediate cash. This can be a lifesaver for companies that deal with extended payment terms, typically ranging from 30 to 90 days or more. Instead of waiting for payment, businesses sell their invoices to a factoring company at a discount, receiving a significant portion of the invoice value upfront. The factoring company then collects the payment from the customer when it’s due.
How AR Factoring Works
1. Qualification: The business checks if it qualifies for factoring. This usually involves a quick assessment of the business’s receivables.
2. Submission of Invoices: The business submits its invoices to the factoring company, either manually or through integrated accounting software.
3. Approval and Funding: Once the invoices are verified, the factoring company advances a percentage of the invoice value to the business, typically between 70% and 90%.
4. Customer Payment: The customer remits the invoice amount straight to the factoring company.
5. Final Settlement: Once the factoring company receives the full payment, it remits the remaining balance to the business, minus the factoring fee.
The Accounting Process for AR Factoring
Setting Up Accounts
1. Create a Liabilities Account: In your Chart of Accounts, create a liabilities account specifically for factored invoices. This account will track the advances received from the factoring company.
2. Create an Expense Account for Factoring Fees: Set up an expense account to track the fees charged by the factoring company.
Recording Factoring Transactions
When You Receive Payment from the Factoring Company
1. Create an Invoice: Record the invoice in your accounting software as you normally would.
2. Record a Deposit: For the deposit account, choose the liabilities account for factored invoices. Enter the full invoice amount as the deposit amount.
3. Record the Factoring Fee: Add a line for the factoring fee in the same deposit transaction. Enter the fee as a negative value.
When the Customer Pays the Invoice
4. Record the Payment: In your accounting software, record the payment received from the customer. Choose “undeposited funds” as the deposit account.
5. Apply the Payment to the Loan: Go to bank deposits and select the payment recorded. Apply it to the liabilities account for factored invoices to net off the advance.
Recourse vs. Non-Recourse Factoring
Recourse Factoring: The factoring company takes on the risk if the customer does not pay. If the customer doesn’t pay the invoice, the industry must repay the advance to the factoring company.
- Journal Entries:
Credit Accounts Receivable for the invoice amount.
Debit Cash for the advance received.
Debit Loss on Sale of Receivables for the factoring fee.
Credit Recourse Liability for the estimated bad debts.
Non-Recourse Factoring: If the customer defaults, the business can’t repay the advance.
- Journal Entries:
Credit Accounts Receivable for the invoice amount.
Debit Cash for the advance received.
Debit Loss on Sale of Receivables for the factoring fee.
Debit Due from Factor for the retained amount.
Advantages of AR Factoring
- Fast Funding: Receive cash within days, not weeks.
- Flexible Working Capital: Fund only the invoices you choose.
- No Debt: AR factoring doesn’t add to your liabilities.
- Maintain Control: You don’t give up equity in your business.
- Reduced Administrative Load: The factoring company handles collections.
Disadvantages of AR Factoring
- Customer Interaction: Some customers may be concerned about dealing with a third-party factoring company.
- Fees: Factoring fees can add up, and some companies may have hidden charges.
- Long-Term Commitment: Some factoring agreements may require you to factor in all invoices or commit to minimum volumes.
Choosing the Right Factoring Company
- Industry Expertise: Select a factoring company with experience in your industry.
- Flexibility: Seek out terms that are adaptable to your business requirements.
- Customer Service: Ensure the factoring company has responsive and helpful customer service.
- Stability: Choose a well-established company with a solid track record.
- Transparent Fees: Be clear about all potential fees to avoid surprises.
Real-World Example: FastGrowth Company
FastGrowth Company factors a $375,000 invoice with Ample Finance on a non-recourse basis. Ample Finance advances 90% of the invoice and charges a 5% fee. Here’s how FastGrowth Company records the transaction:
Record the Advance:
Debit Cash: $337,500
Debit Loss on Sale of Receivables: $18,750
Debit Due from Factor: $37,500
Credit Accounts Receivable: $375,000
Customer Payment:
Debit Cash: $37,500
Credit Due from Factor: $37,500
Conclusion
AR factoring accounting can be a powerful tool for managing cash flow and growing your business. By understanding the accounting process and choosing the right factoring partner, you can leverage this financing option to your advantage. Whether you’re dealing with recourse or non-recourse factoring, accurate accounting is crucial for maintaining financial health and transparency.
For businesses located in California, partnering with experienced AR factoring companies in California can provide local expertise and personalized service. For more detailed guidance on AR factoring accounting, including industry-specific insights and advanced accounting tips, contact us today!
