Accounting, Financial, Taxation

Since my post about Receivable Factoring Guide, many of you asked me a typical question; “what is journal entry for factoring of accounts receivable?” To sum-up the factoring mechanism; when factoring accounts receivable, the receivables are sold to a finance company. The factor buys the accounts receivable at a discount from face value, typically at a discount of 6 percent. Customers are usually notified. The factoring arrangement is usually without recourse, where the risk of un-collectibility of the customer’s account rests with the financing institution. Billing and collection is typically done by the factor. The factor charges a commission ranging from 3/4 percent to 11/2 percent of the net receivables acquired.

The Journal Entry is:

[Debit]. Cash (proceeds)
[Debit]. Loss on sale of receivables
[Debit]. Due from factor (*)
[Credit]. Accounts receivable (face amount of receivables)

Note: (*) proceeds kept by factor to cover possible adjustments such as sales discounts, sales returns and allowances.

Factoring is usually a continual process. The seller of merchandise receives orders and transmits them to the factor for acceptance; if approved, the goods are shipped; the factor advances the money to the seller; the buyers pay the factor when payment is due, and the factor periodically remits any excess reserve to the seller of the goods. There is a continual circular flow of goods and money among the seller, the buyers, and the factor. Once the agreement is in effect, funds from this source are spontaneous

Factoring is usually a continual process. The seller of merchandise receives orders and transmits them to the factor for acceptance; if approved, the goods are shipped; the factor advances the money to the seller; the buyers pay the factor when payment is due, and the factor periodically remits any excess reserve to the seller of the goods. There is a continual circular flow of goods and money among the seller, the buyers, and the factor. Once the agreement is in effect, funds from this source are spontaneous.

Case Example:

Royal Bali Cemerlang factors $200,000 of accounts receivable. There is a 4 percent finance charge. The factor retains 6 percent of the accounts receivable. Appropriate journal entries are:

[Debit]. Cash = $180,000
[Debit]. Loss on sale of receivables (4% × $200,000) = $8,000
[Debit]. Due from factor (6% × $200,000) = $12,000
[Credit]. Accounts receivable = $200,000

Factors provide a dependable source of income for small manufacturers and service businesses.

One more case example:

You need $100,000 and are considering a factoring arrangement. The factor is willing to buy the accounts receivable and advance the invoice amount less a 4 percent factoring commission on the receivables purchased. Sales are on 30-day terms.A14 percent interest rate will be charged on the total invoice price and deducted in advance. With the factoring arrangement, the credit department will be eliminated, reducing monthly credit expenses by $1,500. Also, bad debt losses of 8 percent on the factored amount will be avoided. To net $100,000, the amount of accounts receivable to be factored is:

The effective interest rate on the factoring arrangement is:

0.14/0.82 = 17.07%

The annual total dollar factoring cost is:

Interest (0.14 × $121,951) = $17,073
Factoring (0.04 × $121,951) = 4,878
————————————————– (+)
Total cost = $21,951

Hope this post explains what journal entry for factoring of account receivable is.

Here are jargons commonly used in term with Factoring:

Account Debtor: The customer of a factor’s client. The company owing the money due on the invoices, it is also known as the customer.

Accounts Receivable: Trade credits; is an amount owed by an account debtor by the act of granting short term unsecured credit in lieu of cash for goods or services. Considered a liquid asset on the balance sheet and generally expected to be paid in less than ninety days.

Accounts Receivable Financing: It is a short-term financing technique for working capital purposes, loans to a company are collateralized by a security interest in a company’s account receivables. Account receivables serve as collateral, and loans are made on a percentage of eligible assets pledged.

Acquisition: It is a loan to assist in acquiring the assets of a business.

Asset Based: It is a business loan where the borrower pledges as collateral for the loan any assets used in the conduct of his or her business. Funds are used for business related expenses. All asset-based loans are secured.

Credit: It is a privilege granted for the purpose of extending time to make payment on a debt.

Customer: The client’s customers, is the company which pays the money due under the factored invoice, it is also known as the account debtor.

Dilution: It is the amount of risk associated with collection of the accounts receivable. It can include returns, charge-backs, trade allowances, concentrations, slow pay, bad debt and other perceived risk.

Due Diligence: Is a background check and research conducted by the factor to assess validity of a prospective factoring client and that client’s customers.

Factor: Is the funding source for the client. It is the company which purchases the accounts receivable (invoices) from the client.

Factoring: Is the selling of a company’s accounts receivable to a third party, in order to obtain funding.

Factors Acknowledgment Form: Is a form sent to the client’s customer by the factor, confirming that the client’s invoice does exist and that the customer will remit the payment due under that invoice to the factor.

Factors Advance: Is the money the factor sends to the client up front, after the verification process is complete, and before the factor receives its money from the client’s customer. The advance is figured as a percentage of the face value of the factored invoices.

Factors Charge-Back: Is an amount of money that is owed to the factor and is deducted or Charged-Back from the reserve or availability of the line due to an agreed upon non-payment by debtor clause in the Factors contract.

Factors Client: Is the business which sells its accounts receivable to the factor.

Factors Fee: Is the fee the Factor Charges for funding the clients A/R.

Factors Reserve: Is a deposit maintained by the factor, to guard against disputes between the client and the customer, and to guard against bad debt losses due to customer non-payment. This is the money retained by the factor when the advance is sent to the client. The Reserve is sent to the client after the customer has paid the factor the money due on the invoice.

Factors Reserve Release: Is the amount of money released from the Factors Reserve once payment has been received and credited. The Reserve Release may be less any charge-back or fees associated with the services.

Factors Services: Credit Analysis, Credit Guarantees and Collection Management.

Factors Verification: Process by which the factor verifies that the product or service provided by the client was received and accepted by the customer, and that the customer intends to pay the factor the money due under the invoice. This process takes place before the factor sends the advance to the client.

Recourse: In this type of factoring, the risk of customer non-payment remains with the client. If the client’s customer is financially unable to pay the money due under the invoice, the factor has recourse against the client for that money. The factor is protected against customer non-payment.

Working Capital: Loans for business expenses such as, advertising, wages, rents, and other operational costs. Often these loans are secured by tangible assets or, in the case of long-standing good credit, by the “full faith and credit” of the company.

You may want to read the following sub-topics too:

What is Receivables Factoring?

A basic explaination about receivable factoring.

Types of Factoring

Types of factoring available in the market place.

Advantages and Disadvantages of Receivable Factoring

Learn what advantages and disadvantages of factoring are.

Factoring Fees and Funds Structure [with calculation case example]

A basic explaination about common fees of factoring, how it is structured, explained with case example for easier understanding.

Receivable Factoring - The Funding Process

Basic knowledge about funding process of a factoring.

Choosing A Factoring Company

A considerable guidance on how to choose a right factoring company to meet your need.

A Worth Factoring Buyer’s Tips

Additional worth consider tips for factoring buyer.

1. Don’t automatically accept the first rate a factor offers: negotiate. See if they can save you money with a lower discount rate or reductions of other fees. If not, see if they can offer you a larger advance so you can put more money to work for you.
2. Although price can greatly influence your decision, be careful not to put too much emphasis on price over skill and service. The money you save may not be worth it in the long run if you face long payment periods or unreliable customer service.
3. You don’t have to transfer all of your invoices over to the factor, so pick and choose which invoices you want funded. If you have a large invoice from a customer you know will remit payment right away, collect the funds yourself and skip the factor’s fees.
4. Even though factoring companies notify your clients that payment should go to them, you may want to let your customers know ahead of time. Hearing directly from you will help avoid raising skepticism or concerns.
5. See if the factor belongs to an International organization like the International Factoring Association (IFA). Non-profit groups like the IFA assist professionals in the industry by sharing information, training, and resources to better serve their customers.

You may want to read the following sub-topics too:

What is Receivables Factoring?

A basic explaination about receivable factoring.

Types of Factoring

Types of factoring available in the market place.

Advantages and Disadvantages of Receivable Factoring

Learn what advantages and disadvantages of factoring are.

Factoring Fees and Funds Structure [with calculation case example]

A basic explaination about common fees of factoring, how it is structured, explained with case example for easier understanding.

Receivable Factoring - The Funding Process

Basic knowledge about funding process of a factoring.

Choosing A Factoring Company

A considerable guidance on how to choose a right factoring company to meet your need.

Factoring - Appendix (Jargons)

Jargons commonly used in factoring world.