Accounts receivables (AR) refer to the money owed to a company for goods or services provided. Accounts receivables are considered assets since they represent a future cash inflow to the company. They may be listed as a line item on a company’s balance sheet. In some cases, companies can use their accounts receivable as a source of financing. Receivables financing facilities and factoring are two methods for accessing working capital by unlocking the value tied up in unpaid invoices. These methods can offer certain advantages over traditional bank financing.

The key distinction between receivables financing and factoring is in the ownership of the invoices. Receivables financing just involves obtaining a loan secured by the company’s accounts receivable as the collateral. In contrast, factoring involves a true purchase and sale of the accounts receivable of a company to a factor, which is a third-party specialty financing firm.

A receivables facility is a common type of working capital financing arrangement in which a company can borrow against the value of its outstanding accounts receivables. While receivables facility can involve a single seller and a single buyer, receivables securitization facilities are more prevalent. Receivables securitization involves the sale of the value of a company’s accounts receivables to a special purpose vehicle (SPV). The special purpose vehicle is often managed by a third party. The special purpose vehicle then packages and sells the receivables to a group of investors. A receivables securitization financing agreement establishes the terms of the receivables facility and contains seller representations and warranties regarding the quality of the receivables. The agreement also contains seller covenants, such as requiring the seller to provide periodic reports on the quality of the receivables.

The types of receivables sold depends on the nature of a particular company’s business. A receivables financing agreement will govern the relationship between the borrower (the company) and the lender (a financial firm). Examples of receivables sold pursuant to a receivables financing agreement include medical bills, utility bills, automotive supply bills, and unpaid invoices for consulting services previously rendered.

A factoring accounts receivable purchase agreement memorializes the relationship between the factor and the client. In a factoring arrangement, the factor will purchase the accounts receivable of a business (the client company) for an agreed duration. In return, the client will pay a factoring commission to the factor.

Most factoring arrangements are non-recourse. This means that if a client’s customers fail to pay for the goods or services that generated the accounts receivable, the factor is still obligated to pay the company for the purchased accounts receivable. It is therefore important for the factor to diligence the creditworthiness of the client’s customers prior to entering into the factoring purchase arrangement.

The two basic types of factoring are maturity factoring and collection factoring. Maturity factoring typically involves a wholesale business as a client. The accounts receivables of the wholesale client are generated from manufacturers or distributors. Collection factoring typically involves a retail business as the client.

In most factoring arrangements, the client’s customers are required to be notified that the client company has sold its accounts receivables to a factor. In notification factoring, the factor can directly collect outstanding amounts from the client’s customers in connection with the purchased receivables.