Overview of factoring agreements

Overdue account balances and invoices are a huge liability for companies, especially when it limits their cash flow. However, you can turn these debts into immediate cash through a process called “factoring.” With factoring agreements, companies referred to as “factors” purchase your outstanding invoices at a discounted rate. The factor then pursues the debt for the full face value of the invoices.

Types of factoring agreements

There are two main types of factoring agreements: advance agreements and maturity agreements (or collection agreements).

An advance arrangement involves sending invoices to customers after goods are delivered. For example, a building supply company may deliver 25 pieces of lumber to a construction site and then bill the client “$500 net 30.” This means the construction company has 30 days to pay the invoice. While advance agreements encourage customers to place larger orders, they can also lead to a large number of outstanding accounts receivables which can negatively impact a company's cash flow. Selling a portion of the outstanding invoices can help ease a cash crunch.

With a maturity agreement, companies sell their credit accounts or outstanding accounts receivables. This arrangement is typical with companies that work a lot with in-house credit accounts. When a credit account goes into default, the company extending the credit can opt to sell the account to a factor. For instance, a company may offer its default credit accounts to a factoring company at a 15% discount. This way, it recovers 85% of the debt, and the company buying the invoices can pocket the 15% difference.

Structure of factoring agreements

There are several key parts to factoring agreements.

1. Identifying the contracting parties – The company who sells the accounts and the factor who buys them.
2. Defining the discount, or factoring fee – The amount the company allows the factor to keep when collecting the full value of the invoices. This can range from 10% to 20% depending on how risky the business is.
3. Detailing what accounts are being sold – Account numbers or customer names and addresses can be used for identifying the accounts. The value of each account also needs to be identified so that the value of the transaction can be verified.

Unsure which factoring agreement is right for your company? BuyerZone can help. Submit a free request for factoring price quotes, and we’ll match you with multiple companies who will help narrow down your decision.