The buyer pays the seller for the outstanding receivables on their average due date. The factor carries out the entire credit and collection process. The factor is paid a fee for providing this service that takes into account estimated credit losses.
The receivables may be sold with or without recourse.
Here the seller is paid by the factor in advance (before the average due date) and receives an amount based on the invoiced amount less an allowance for credit losses. In turn the factor is paid interest on average balances some way above that paid on loans made to companies of a similar credit standing.
We have already alluded to the fact that a large portion of working capital is tied up in accounts receivables at many companies. These are moneys due from customers for services or products that have been delivered and invoiced but for which payment has not yet been received. This is not unusual, typical payment terms are 30–60 days and may even be as long as 90 days. Companies wanting to receive their cash faster look to banks and specialist finance companies for factoring services by selling them the rights to the cashflows represented by accounts receivable. Factoring may be arranged such that the factor collects directly from the seller or the seller carries out this function and remits proceeds as they are received.