Quick overview

Loan factoring (sometimes called invoice factoring or accounts receivable factoring) turns unpaid invoices into cash by selling them to a third party known as a factor. The immediate effect is higher cash on hand, but how the transaction is reported—either as a sale of receivables or as a financing arrangement—determines whether your balance sheet shows less receivables or a new liability.

This article explains the accounting and practical effects of factoring, shows simple examples with numbers, outlines common pitfalls, provides negotiating tips, and points to further reading and internal resources.

Note: This content is educational and not a substitute for tailored accounting or legal advice. Consult your CPA or financial advisor about how a specific factoring agreement will be reported under U.S. GAAP (ASC guidance) and how it affects tax and covenant compliance.

How factoring is usually structured

There are basic pieces that appear in nearly every factoring agreement:

  • Advance rate: the percentage of an invoice the factor pays upfront (commonly 70–90%).
  • Reserve: the portion withheld to cover disputes, returns, or chargebacks; eventually released to the seller minus fees.
  • Discount or factor fee: the price charged by the factor for providing the service, usually expressed as a percentage of invoice value or as a monthly rate.
  • Recourse vs. non-recourse: determines who bears credit risk if a customer fails to pay.
  • Notification: disclosed factoring (customers are notified the factor will collect) versus confidential factoring (customers aren’t told).

Authoritative resources such as the Consumer Financial Protection Bureau and the U.S. Small Business Administration describe factoring as a common small-business financing option but recommend careful contract review before signing [CFPB; SBA].

Sources: Consumer Financial Protection Bureau (consumerfinance.gov), U.S. Small Business Administration (sba.gov).

Accounting: sale vs. secured borrowing (why it matters)

The single biggest question for your balance sheet is whether the factoring arrangement qualifies as a “true sale” (derecognition of the receivable) or must be treated as a secured borrowing (the receivable stays on the balance sheet and a liability is recorded). Under U.S. GAAP transfer-and-derecognition rules (ASC 860 et al.), factors include the presence of control transfer and whether the seller retains significant continuing involvement.

  • If the factor obtains control and the transfer meets sale criteria, your company derecognizes the receivable. The balance sheet shows:

  • Cash increases (current asset)

  • Accounts receivable decreases (current asset)

  • Any difference between cash received and carrying value of receivables is recorded as a factoring fee or loss on sale in the income statement

  • No new liability is recorded for the factored receivables

  • If the arrangement is a secured borrowing (common when the company retains significant obligations or the factor has recourse), the receivables usually stay on the books and you record a financing liability (often labelled “financing payable” or “due to factor”) for the amount advanced.

  • Cash increases

  • Accounts receivable remains or is pledged as collateral

  • A liability equal to the advance (or the borrowing amount) appears on the balance sheet

  • Interest or factoring fees are recognized as financing expense

In my practice advising growth-stage clients, I’ve seen many companies assume factoring is always a sale; in reality, the contract’s recourse, control, and disclosure provisions matter for accounting treatment.

Example 1 — Treated as a true sale (derecognition)

Company A factors $100,000 of invoices with a 80% advance and a 3% factoring fee. Cash received = $80,000. Assume carrying value of receivables equals face value for simplicity.

  • Before factoring: Cash $10,000; AR $100,000
  • After factoring: Cash $90,000 (10,000 + 80,000); AR $0 (derecognized)
  • Expense recorded: Factoring fee = 3% × $100,000 = $3,000 (reported on P&L)

Net effect: Current assets decreased by $13,000 (AR down $100,000, cash up $80,000) but liquidity improved because cash is now available for operations. The balance sheet shows no new debt if the sale is bona fide.

Example 2 — Treated as a secured borrowing (recourse or pledge)

Company B factors the same $100,000 of invoices but agreement is recourse and viewed as financing. Advance = $80,000.

  • Before factoring: Cash $10,000; AR $100,000
  • After factoring: Cash $90,000 (10,000 + 80,000); AR $100,000 (remains on books, but disclosed as pledged collateral)
  • Liability recorded: Financing payable $80,000
  • Financing expense: 3% fee treated like interest = $3,000 on P&L

Net effect: Current assets increase by $80,000 in cash but AR remains. You also add $80,000 of short-term liabilities. This often makes working-capital ratios look worse than a true sale would.

How factoring affects key ratios and metrics

  • Liquidity (current ratio, quick ratio): Depends on accounting treatment. True sale may raise cash and remove AR, sometimes improving quick ratio; borrowing increases current liabilities and may worsen current ratio.
  • Leverage: Treated as a sale—no new debt—so leverage (debt-to-equity) may not change. As borrowing—debt rises and leverage increases.
  • Days Sales Outstanding (DSO): Factoring lowers DSO if receivables are derecognized since invoices are no longer outstanding on your books.
  • Profitability: Factoring fees reduce net income; compare fees to the opportunity cost of delayed payments or higher-interest loans.

Practical considerations for management and lenders

  • Debt covenants: If your business has loan covenants tied to leverage or liquidity, factoring treated as borrowing can trigger covenant breaches. Share factoring contracts with lenders and your CPA before closing deals.
  • Customer relationships: With disclosed factoring, the factor collects from customers. Choose a factor with aligned customer-service standards to avoid damaging relationships.
  • Tax implications: Fees are usually deductible business expenses, but treatment should be confirmed with your tax advisor.

Questions to ask a factor (checklist)

  • Is the arrangement recourse or non-recourse? Who bears customer credit risk?
  • Will you notify my customers? Is the program non-notification (confidential)?
  • What is the advance rate, reserve policy, and timeline for reserve release?
  • How are fees structured (flat fee, sliding scale, monthly charge)?
  • Will the agreement require me to repurchase disputed receivables or make representations that could create continuing involvement?
  • How will you report collections and disputes to me and my customers?

Negotiation tips

  • Shop rates and read the fee schedule carefully—items like due-diligence fees, termination fees, and wire fees add up. (Compare options in our guide: Invoice Financing vs. Factoring.)
  • Seek the highest possible advance and the shortest reserve holdback period.
  • Negotiate customer-notification terms if maintaining direct customer relationships is critical.

Internal resources: see our glossary entry on Factoring and the comparison piece Invoice Financing vs. Factoring: Which Fits Your Cash Flow Needs? for alternatives and side-by-side pros/cons.

Common mistakes and misconceptions

  • Mistaking factoring automatically as “debt”: it can be a sale, but not always. Contracts matter.
  • Ignoring covenant language: companies rush to factor for cash and later run into covenant issues.
  • Overlooking hidden costs: fees beyond the stated discount (e.g., chargeback fees) can increase effective cost substantially.

When factoring is a good fit

  • You have predictable, creditworthy customers and steady invoice volume.
  • You need working capital quickly to seize growth opportunities or smooth seasonal cycles.
  • Traditional bank financing is unavailable or slower than you can afford.

When to pause

  • If your customers are highly sensitive to third-party collectors.
  • If factoring expenses exceed the value of alternative financing after considering taxes and opportunity cost.
  • If your existing lender prohibits assignment of receivables or requires approval.

Final takeaways

Loan factoring is a powerful operational tool that can materially change the appearance of your balance sheet and your company’s cash dynamics. The key is understanding whether your agreement is a sale or a borrowing, how fees are recognized, and what the transaction does to covenants and ratios. In my experience advising businesses for over 15 years, clear contract terms and advance vetting of accounting and covenant impacts prevent most downstream surprises.

For further reading and close comparisons of options, review our glossary pages on Factoring and Invoice Financing vs. Factoring: Which Fits Your Cash Flow Needs?.

Professional disclaimer: This article is for educational purposes only and does not constitute accounting, tax, or legal advice. Consult your CPA, tax advisor, or attorney before entering a factoring contract.

References

  • Consumer Financial Protection Bureau, “Understanding Financing Options for Small Businesses” (consumerfinance.gov)
  • U.S. Small Business Administration, “Financial Assistance for Small Businesses” (sba.gov)
  • FASB ASC 860, Transfers and Servicing (guidance on receivable transfers and derecognition)