Mechanics of a Factoring Transaction - Kronos Capital White Paper Series

For businesses that have not entered into a factoring transaction in the past, the concept of engaging into a financial transaction that is mechanically foreign to the traditional principals can be daunting.

We prize intellectual capital as a driving force in creating economic value.

However, factoring is quite intuitive and very simple. Factoring is the sale of accounts receivable or invoices for immediate cash between two parties in agreement. Factoring is different from a conventional bank credit facility due to the sale aspect of the receivables – the commitment to collect the amount due on the receivable or invoice is the obligation of the factor, not the business that created the receivable.

A conventional factoring transaction has the following elements:

1) Company A sells and then delivers products to Buyer ( also known as an “account debtor”) and presents company with an invoice

2) Buyer agrees to pay the invoice/account receivable 60 days after widget delivery

3) Company A must pay in full the widget manufacturer in 10 days

4) Factor purchases the invoice and Buyer’s promise to pay on the invoice from Company A at an agreed upon discount plus a reserve. Company A uses these proceeds to pay manufacturer or for general corporate use

5) In 60 days, the buyer pays the factor in full all amounts due and payable under the invoice and the factor eventually remits to Company A the reserve less any outstanding expenses and fees

Most traditional factoring transactions are constructed as revolving cash facilities. As such, the factor will permit the client (Customer A in the diagram) to sell as many invoices and accounts receivable to the factor as long as the aggregate amount of unpaid invoices purchased by the factor in not greater than an agreed-upon level (the maximum facility amount). Some traditional factoring programs are created so that the client will only sell one or two (generally large) invoices in one-off transactions, but these type of arrangements are the exception, not the rule. This type of factoring is frequently known as “spot factoring.”

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