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A factoring arrangement is a purchasing agreement under which a person or entity such as a corporation acquires outstanding debts, invoices, or accounts receivable at a discount from another entity, usually a company. The factoring arrangement is very common in the textile industry, although in the late 20th century, financial firms began to take an interest in the factoring arrangement as well, sometimes to the detriment of the consumer, who is often unaware that his or her accounts payable may be sold to another company with differing payment policies than the original creditor. The factoring arrangement has been common in the United States since before the Revolution, but in recent years, mergers and consolidation have dramatically changed the way in which factoring arrangements are handled. Among other things, the number of “factors,” or companies that purchase bulk accounts receivable, has shrunk into a small number of megalithic corporations.
Companies generate outstanding accounts payable by selling goods or services to consumers or other companies on credit, and they periodically choose to factor their debt by entering into a factoring arrangement with other parties, wherein their outstanding accounts receivable are cleared, albeit at a discount, and another company is responsible for the recovery of the monies owed. For many companies, debt is capital, and the factoring arrangement is an excellent way to leverage that capital and put it into usable form, especially in high volume industries with large amounts of creditors, such as the textile trade.
The factoring arrangement can be a gamble for the factor assuming the invoices, because there may be bad debts or other obstacles to collection of the funds. As a result, factors have begun running credit checks and assessing the financial health of potential clients before entering into a factoring arrangement, especially as a growing number of factors are handling the retail trade, which in turn is facing a large amount of consumer debt, some of which may not be recoverable. Clients provide annual reports and other indicators of financial health to factors before they are approved. Factors often establish a credit line with clients and dictate the amount of credit that their clients can offer to customers.
Traditionally, there are two types of factoring arrangements. The first is called an “advance” arrangement, in which the factor remits payment after the client has shipped goods to customers. The other is a “maturity” or “collection” arrangement, in which the factor pays for invoices in chunks, either on the posted due date or when the invoices are purchased by the factor. In some cases, customers are notified that the invoices have been transferred to a factor and instructed to remit payments accordingly. However, this is not always the case, and sometimes clients are unaware that their invoices are involved in a factoring arrangement.
The face of factoring arrangements has changed since the 1970s, with a higher percentage of retail trade involved in factoring, a smaller number of overall factors, and much higher risks. With change in the late 20th century came more consumer awareness and transparency regarding factoring arrangements, and more caution of the part of factors. The end result is billions of dollars in capital feeding the financial industry, and ultimately the economy.