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Factoring loans are a way in which a company can improve its cash flow by getting immediate access to cash based on money it is owed by clients but has not yet collected. Strictly speaking, this can be a sale of an asset rather than a loan, though in some cases the money may have to be repaid. The main difference between the various types of factoring loans involves what happens if the company that issues the factoring loan is unable to get payment from the business's clients. Depending on the agreement, the business that took out the loan could face no consequences, not receive the full agreed amount, or be forced refund money that it has already received.
The basic principle of factoring loans is that a business gets cash up front from a third party finance company. This cash is based on the money the business is owed by clients. The finance company then recovers the money from the clients. The business only gets paid a proportion of the total invoice amount, with the difference being kept by the finance company.
The terms used for various forms of factoring can be inconsistent and confusing. The different types fall into two main categories: those in which the finance company takes on all risks for the outstanding debts, and those in which some or all of the risk remains with the business. There are different ways to describe these categories: one way is to describe the first category as debt factoring and the second category as invoice discounting. Another set of terms to describe them non-recourse for the first category and recourse for the second category.
There are several different variants of factoring loans where the business will retain some risk. A common format is for the finance company to pay some of the money up front, but only hand over the rest of the agreed payment if and when it collects the money from the client. Another variant is for the finance company to attempt to collect an invoice for a certain time, such as 90 days, after which the business must either refund the relevant money to the finance company, or negotiate a new agreement with a further fee.
In practice, whether to refer to factoring as a loan is only really significant when it comes to financial accounts. Depending on the prevailing accounting rules, money from factoring where the business no longer bears any risk can be listed as a cash asset. In situations where the business retains some risk, the money may have to be listed on balance sheets as an outstanding loan, even though the business already has the money in hand.