While factoring may allow the liable party to be relieved of the debt for less than the full amount, it is generally designed to be more beneficial to the factor, or new owner, and the seller of the account than to the debtor. The seller receives working capital, while the buyer is able to make a profit by buying the account for substantially less than what it is worth and then collecting on it. Factoring allows a buyer to purchase such accounts for about 25% less than what they are
actually worth.
The factor takes full responsibility for collecting the debt. The factor is required to pay additional fees, usually a small percentage, once collection efforts prove successful. The new owner of the account may offer the liable person or entity a small discount on the outstanding debt. Other arrangements are sometimes made, in which the debt is considered paid in full if a lump sum payoff is made under certain terms and conditions. Unfortunately, in some cases, factoring can cause the consumer or indebted company a great deal of financial stress, such as in the case of debt consolidation.
For example, if a person joins a debt consolidation program and one creditor engages in factoring, then the entity that purchases the account may not be bound by the program's contract with the original creditor. The factor may demand a large sum to consider the account current, and may increase interest rates as well as the monthly payment amount. This form of factoring may prove profitable in some cases, but in others it may backfire. The debtor may have no choice but to file for bankruptcy because he or she simply cannot afford the inflated interest rates and payment amounts. In the majority of cases, factoring is a profitable venture, but it is a good idea to review each account on an individual basis before deciding how to proceed.
Accounts receivable (A/R) is one of a series of accounting transactions dealing with the billing of customers who owe money to a person, company or organization for goods and services that have been provided to the customer. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms.
An example of a common payment term is Net 30, meaning payment is due in the amount of the invoice 30 days from the date of invoice. Other common payment terms include Net 45 and Net 60 but could in reality be for any time period agreed upon by the vendor and client.
While booking a receivable is accomplished by a simple accounting transaction, the process of maintaining and collecting payments on the accounts receivable subsidiary account balances can be a full time proposition. Depending on the industry in practice, accounts receivable payments can be received up to 10 - 15 days after the due date has been reached. These types of payment practices are sometimes developed by industry standards, corporate policy, or because of the financial condition of the client.
On a company's balance sheet, accounts receivable is the amount that customers owe to that company. Sometimes called trade receivables, they are classified as current assets. To record a journal entry for a sale on account, one must debit a receivable and credit a revenue account. When the customer pays off their accounts, one debits cash and credits the receivable in the journal entry. The ending balance on the trial balance sheet for accounts receivable is always debit.
Business organizations which have become too large to perform such tasks by hand (or small ones that could but prefer not to do them by hand) will generally use accounting software on a computer to perform this task.
Associated accounting issues include recognizing accounts receivable, valuing accounts receivable, and disposing of accounts receivable.
Accounts receivable departments use the sales ledger. Accounts receivable is more commonly known as Credit Control in the UK, where most companies have a credit control department.
Other types of accounting transactions include accounts payable, payroll, and trial balance.
Since not all customer debts will be collected, businesses typically record an allowance for bad debts which is subtracted from total accounts receivable. When accounts receivable are not paid, some companies turn them over to third party collection agencies or collection attorneys who will attempt to recover the debt via negotiating payment plans, settlement offers or legal action. Outstanding advances are part of accounts receivables if a company gets an order from its customers with payment terms agreed in advance. Since no billing is being done to claim the advances several times this area of collectible is not reflected in accounts receivables. Ideally, since advance payment is mutually agreed term, it is the responsibility of the accounts department to take out periodically the statement showing advance collectible and should be provided to sales & marketing for collection of advances. The payment of accounts receivable can be protected either by a letter of credit or by Trade Credit Insurance.
Companies can use their accounts receivable as collateral when obtaining a loan (asset-based lending) or sell them through factoring (finance). Pools or portfolios of accounts receivable can be sold in the capital markets through a securitization.
Bookkeeping for Accounts Receivable
Companies have two methods available to them for measuring the net value of account receivables, which is computed by subtracting the balance of an allowance account from the accounts receivable account.
The first method is the allowance method, which establishes a liability account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable. The amount of the bad debt provision can be computed in two ways - either by reviewing each individual debt and deciding whether it is doubtful (a specific provision) or by providing for a fixed percentage, say 2%, of total debtors (a general provision). The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement.
The second method, known as the direct write-off method, is simpler than the allowance method in that it allows for one simple entry to reduce accounts receivable to its net realizable value. The entry would consist of debiting a bad debt expense account and crediting the respective account receivable in the sales ledger.
The two methods are not mutually exclusive, and some businesses will have a provision for doubtful debts and will also write off specific debts that they know to be bad (for example, if the debtor has gone into liquidation.)
For tax reporting purposes, a general provision for bad debts is not an allowable deduction from profit - a business can only get relief for specific debtors that have gone bad. However, for financial reporting purposes, companies may choose to have a general provision against bad debts in line with their past experience of customer payments in order to avoid over stating debtors in the balance sheet.
An invoice or bill is a commercial document issued by a seller to the buyer, indicating the products, quantities, and agreed prices for products or services the seller has provided the buyer. An invoice indicates the buyer must pay the seller, according to the payment terms.
From the point of view of a seller, an invoice is a sales invoice. From the point of view of a buyer, an invoice is a purchase invoice. The document indicates the buyer and seller, but the term invoice indicates money is owed or owing. In English, the context of the term invoice is usually used to clarify its meaning, such as "We sent them an invoice" (they owe us money) or "We received an invoice from them" (we owe them money).
