Accounts receivable financing is also known as factoring is a method of selling the accounts receivable in order to obtain cash to run the operations of the company. As we know accounts receivable are the amount of money of a company owed by the customers that is needed to be paid by them in return of the products or services provided by the company.
Let’s say Company XYZ deals in selling cotton garments. It has about $1 million in receivables from customers who have not paid for their consignments of garments. Company XYZ needs cash right away because it is trying to finish building a new production unit along the side of the factory. As we know that accounts receivable is an asset, and as such, it appears on the balance sheet. In particular, account receivable is a current asset, meaning that the amount owed is expected to be received within the next 12 months.
Company XYZ calls a factor, which purchases the receivables for $750,000. In the deal, Company XYZ gets $750,000 right away, and the factor gets the right to all the money from the receivables ($1 million). A factor is a financial institution that purchases receivables from a company. The factor then assumes the risk of customers paying late or not paying at all.