Definition of Factoring
Factoring is a financing method in which a business sells its accounts receivable (unpaid invoices) to a third party, known as a factor, in exchange for immediate cash. The business receives a large portion of the invoice value upfront, while the factor takes over the right to collect payment from the customer.
How Factoring Works
When a company factors an invoice, the factor typically advances 80–90% of the invoice amount immediately. Once the customer pays the invoice in full, the factor remits the remaining balance to the business, minus a fee. This allows the business to access cash without waiting for standard payment terms such as Net 30, Net 60, or Net 90.
Factoring Explained for a General Audience
For a general audience, factoring is like getting paid early for a bill that hasn’t been paid yet. Instead of waiting weeks or months for a customer to pay, a business can sell that invoice to a factoring company and receive most of the money right away. The factoring company then waits for the customer to pay and keeps a portion as its fee.
Why Companies Use Factoring
Factoring is commonly used to improve cash flow and working capital. It helps businesses cover expenses like payroll, inventory, or operating costs without waiting for customers to pay. This can be especially helpful for companies with slow-paying clients or fast growth that strains cash reserves.
Factoring and Credit Risk
In factoring, the factor typically evaluates the creditworthiness of the business’s customers, since those customers are responsible for paying the invoices. Factoring can be structured as recourse or non-recourse. In recourse factoring, the business may be responsible if the customer does not pay. In non-recourse factoring, the factor absorbs the credit risk, usually in exchange for higher fees.
Factoring vs Loans
Factoring differs from traditional loans secured by receivables. In factoring, the invoice is sold outright as an asset, and the factor often collects payment directly from the customer. In a loan, the business keeps the receivable but uses it as collateral, and remains responsible for repayment regardless of whether the customer pays.
Factoring in Traditional Industries
Factoring has long been used in industries such as manufacturing, logistics, staffing, and construction, where payment terms are long and cash flow timing is critical. It is a well-established method of receivables financing.
Factoring in Ratio’s Context
Ratio Trade is conceptually similar to factoring but applied to subscription and SaaS contracts rather than individual invoices. Instead of factoring a single delivered invoice, Ratio purchases the rights to future subscription payments through a True Sale structure. This allows companies to convert annual or multi-year contracts into immediate cash.
How Factoring Relates to Ratio Trade
Like factoring, Ratio Trade advances a significant portion of future revenue upfront and collects payments over time from customers. The fee charged by Ratio functions similarly to a factoring discount, compensating for time, risk, and capital provided. The key difference is that Ratio applies this model to recurring revenue contracts rather than one-time invoices.
Why Factoring Matters in a Glossary Context
Including factoring in a glossary helps explain a foundational financing concept that underpins modern revenue-based and contract-based financing models. Understanding factoring provides context for how companies can turn receivables or contracts into immediate liquidity.
Summary
Factoring is a form of receivables financing that allows businesses to sell unpaid invoices for immediate cash. It improves cash flow by accelerating payment timing at the cost of a fee. Ratio extends this concept to SaaS and subscription contracts, enabling companies to treat recurring revenue as an asset that can be converted into upfront capital.
