Types of Factoring in Financial Services

What is factoring?

Factoring is a financing arrangement where a business sells unpaid invoices, also called accounts receivable, to a factoring company in exchange for cash upfront. Instead of waiting 30 or 60 days for customers to pay, the business gets earlier access to funds to support cash flow and working capital.

There are different types of factoring, and they mainly differ based on who takes the risk if a customer does not pay, whether the customer is notified, and whether the invoices are domestic or international.

Key Takeaways

• Factoring turns unpaid invoices into upfront cash to support working capital and cash flow.
• The main differences across types of factoring are risk (recourse vs non recourse), disclosure (notified vs confidential), and timing of funding (advance vs maturity).
• Factoring can be domestic or export focused, and it can be used one time (spot) or as an ongoing setup (regular).
• Costs often include a discount rate plus optional service fees for credit and collections support.
• Factoring can help operations run smoothly, but fees and customer experience should be weighed up front.

How factoring works

Here is a simple example:

1. Invoice is issued: Company A sells products worth $10,000 and gives the customer 30 to 60 days to pay.
2. Invoice is sold to a factor: Company A sells that invoice to a factoring company.
3. Fees are deducted: The factoring company charges a fee.
4. Upfront payment is made: The factoring company pays an advance on the invoice value, giving Company A quick cash flow
5. Customer pays the factor: When the customer pays the invoice, the factoring company collects the funds.
6. Remaining balance is paid out:  The factoring company sends the remaining amount to Company A, minus any additional agreed fees.

Types of factoring

Recourse factoring

With recourse factoring, the business is still responsible if the customer does not pay. If the invoice goes unpaid, the factoring company can require the business to reimburse the loss or buy the invoice back.

Because the factoring company is taking on less risk, this option often costs less.

Non recourse factoring

With non recourse factoring, the factoring company accepts the risk of customer non payment, at least under the terms of the agreement. If the customer fails to pay, the factoring company generally cannot ask for repayment from the business.

This option often costs more because the factoring company is taking on more risk.

Full service factoring

Full service factoring, sometimes called old line factoring, is the most hands on option. The factoring company may also:

• Manage the sales ledger
• Send account statements to customers
• Follow up on payments and handle collections
• Review customer credit and set credit limits
• Arrange credit insurance to reduce risk

Businesses often choose this model because it reduces the workload on their internal finance team. The tradeoff is cost. It usually comes with higher fees because more services are included.

Domestic factoring

Domestic factoring is used when the business, the customer, and the factoring company are all based in the same country. Since everyone operates under similar legal and banking systems, the process is usually simpler.

Export factoring

Export factoring supports international sales. Along with the business, customer, and factor, there may also be an import factor in the customer’s country. This setup can help with local collections and credit evaluation across borders, but it also requires experience with international trade and documentation.

Spot (Single Invoice) factoring

Spot factoring is a one time deal where a business sells a single invoice to a factor. This works well when a company needs quick cash for a specific situation, but does not want an ongoing factoring agreement.

Regular factoring

Regular factoring is an ongoing relationship where a business factors invoices on a continuing basis. Instead of selling one invoice here and there, the business can factor multiple invoices over time, which can create a more consistent source of working capital.

Advance factoring

With advance factoring, the factoring company pays a large portion of the invoice value upfront, often somewhere around 75% to 90%. The rest is paid after the customer settles the invoice, minus any agreed fees. This is commonly used when a business needs cash right away.

Maturity factoring

Maturity factoring works differently. The factoring company still collects payment from the customer, but the business receives its funds on the invoice due date, not upfront. This option is typically used when the main goal is outsourcing collections and credit management, not immediate cash.

Disclosed and non disclosed factoring

These options control whether the customer knows a factor is involved.

Disclosed factoring (also called bulk or notified factoring) means the customer is told the invoice has been assigned to a factor. The invoice includes a notice instructing the customer to pay the factoring company directly. This is often referred to as a notice of assignment.

Non disclosed factoring (also called confidential factoring) means the customer is not informed. The factoring company provides an advance, but the customer pays the business as usual. The business then forwards the funds to the factor. 

Bank participation factoring

In most factoring deals, the factoring company does not pay the full invoice value upfront. A common setup is that the factoring company advances around 80% and holds the rest until the buyer pays.

Bank participation factoring helps when the supplier needs more cash than the factor’s advance. In this structure, a bank provides a separate loan based on the remaining invoice value that has not been advanced.

Example:

• Invoice value: $100,000
• Factor advance: $80,000
• Remaining value: $20,000
• Bank loan: The bank may lend against that remaining $20,000 under a separate agreement
  

Limited factoring

Limited factoring, sometimes called selective factoring, means the factoring company only takes on certain invoices instead of the full receivables ledger. The factoring company may decide which invoices to handle based on risk, cost, or internal capacity.

In some cases, it can be buyer based. That means the factoring company focuses on receivables tied to specific customers, rather than processing every invoice the seller issues.

Supplier guarantee factoring

Supplier guarantee factoring is also known as drop shipment factoring or vendor guarantee factoring. It involves three parties: the vendor, the supplier, and the factoring company.

In this type of factoring, the factoring company guarantees the supplier will get paid once the buyer accepts the goods. The factoring company then pays the supplier directly using the future receivables that will be collected from the buyer. After the buyer pays, the factoring company deducts fees and sends the remaining balance to the vendor.

This structure can help businesses take on opportunities they might otherwise miss, especially when suppliers are cautious about extending credit.

Reverse factoring

Reverse factoring, also called supply chain financing, flips the usual setup. It is started by the buyer, not the supplier. The buyer works with a factoring company so suppliers can get paid early on approved invoices. In some arrangements, the buyer pays the factoring fees.

This is often used when the buyer is a larger company and the supplier is a smaller or mid sized business. The supplier gets faster access to cash, and the buyer may get more time to pay.

Factoring vs traditional bank loans

Factoring and bank loans can both provide funding, but they work differently.

Collateral

Many bank loans require collateral. Factoring often does not use collateral in the same way because the invoice itself is the asset being sold.

Approval and speed

Bank loans can involve a longer approval process and deeper review of the business. Factoring is often faster because the factoring company looks closely at the creditworthiness of the customers who owe on the invoices.

Risk

With some types of factoring, part of the risk of non payment can shift to the factoring company. With a bank loan, the business still carries the risk tied to its customer payments.

Talk to a factoring expert

If you are considering factoring and want help choosing the right structure, New Century Financial can walk you through the options based on your business, your customers, and your cash flow needs.

Reach out to New Century Financial to discuss your situation and get a clear recommendation on the type of factoring that fits best, along with what the process would look like for you.