Before You Start

This guide assumes you have an understanding of accounts receivable and liability accounts. Ensure your general ledger is organized.

Overview

30 min
Setup Time
Advanced
Difficulty
Ongoing
Maintenance

What You’ll Learn

  • How to record the initial cash advance from factored invoices
  • Accounting for factor fees and commissions
  • Handling the reserve holdback from factoring
  • Writing off uncollectible factored receivables

1. Preparation Steps

Before recording any factoring transactions, ensure you have these accounts:

Required Accounts

  • Accounts Receivable (Asset)
  • Cash (Asset)
  • Factoring Fee Expense (Expense)
  • Due from Factor / Factoring Reserve (Asset)
  • Bad Debt Expense (Expense - if applicable for recourse factoring)

Key Concepts

  • Recourse vs. Non-Recourse Factoring
  • Discount Rate / Factor Rate
  • Reserve Holdback

2. Factoring vs. Line of Credit

Understand the primary differences between these financing methods.

Option A: Factoring Receivables

This involves selling your invoices to a third party (the factor).

Pros:
  • Immediate cash injection.
  • No long-term debt on balance sheet.
  • Improves cash flow.
Cons:
  • Higher cost of financing.
  • Potential loss of customer relationship.
  • Can impact future AR management.

Option B: Traditional Line of Credit

A flexible loan that allows you to draw funds as needed, up to a limit.

Expert Tip: Factoring is best for businesses needing immediate liquidity without increasing traditional debt, especially when facing seasonal cash flow gaps or rapid growth. However, always understand the full cost implications compared to other financing options.

3. Step-by-Step: Journal Entries for Factoring

Here is the high-level workflow for properly accounting for factored receivables.

Here is a sample journal entry for recording an initial cash advance.

// Scenario: Invoice for $10,000, 80% advance, 20% reserve, 2% factor fee
// Initial Advance:
Debit Cash                                  8,000.00
Debit Due from Factor (Reserve)             2,000.00
    Credit Accounts Receivable                          10,000.00
// To record cash advance from factored invoices

4. Journal Entries Explained

  1. 1

    Record Initial Cash Advance

    Debit Cash for the amount received, Debit ‘Due from Factor’ (an asset account) for the reserve holdback, and Credit Accounts Receivable for the full face value of the factored invoices.

  2. 2

    Account for Factor Fees

    Once fees are assessed, Debit Factoring Fee Expense and Credit ‘Due from Factor’. This reduces the amount the factor owes you from the reserve.

  3. 3

    Record Reserve Release

    When the factor collects the full invoice amount and releases the reserve (minus fees), Debit Cash for the amount received and Credit ‘Due from Factor’.

  4. 4

    Handle Uncollectible Invoices (Recourse)

    If you’re in a recourse factoring agreement and an invoice becomes uncollectible, you may Debit Bad Debt Expense and Credit ‘Due from Factor’ if the factor claws back the advance from your reserve.

Common Error: Incorrect AR Reduction

Ensure you only reduce your Accounts Receivable by the full invoice amount at the time of factoring, not just the cash received. The ‘Due from Factor’ (reserve) is a current asset representing the amount still owed to you by the factor.

5. Review Checklist

Factoring Transaction Review

  • Cash balance correctly reflects the initial advance
  • Accounts Receivable is reduced by the total factored amount
  • ’Due from Factor’ / ‘Factoring Reserve’ asset account is accurately tracked
  • Factoring Fee Expense is recognized correctly
  • Final cash payout from factor reconciles with ‘Due from Factor’ balance

Need Help?

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