Business factoring is a type of financing (also called accounts receivable financing) in which a company sells their accounts receivables to another company at a discounted price. The company that buys the receivables is called a factor, hence the name factoring. The factor provides financing to the company and is then responsible for collecting the debts owed.

For a business with lots of debts owed to them, business factoring is a convenient way to turn those IOUs into capital. The financing they receive can be used to reinvest in their business, repay their debts, or anything other than collecting outstanding invoices. While the financing they get isn't the same amount as the face value of the debts, they don't have to exert any expenses to collect payment; they leave those headaches to the factor.

Two Types of Business Factoring

There are two similar, yet significantly different, types of business factoring: recourse and non-recourse. In recourse factoring, the business that sells the accounts receivables--the client--assumes the credit risk of the debtors. That is, if the debtors default, then the client is responsible for repaying any monies owed.

On the other hand, non-recourse factoring is when the factor assumes the risk of non-payment. If the debtors fail to pay, or if they claim bankruptcy, for example, then the factor assumes the loss. In either case, however, the task of collection is in the hands of the factor, letting the company that sold their IOUs get back on their feet and focus on production rather than bill collecting.