When it comes to businesses dealing with seasonal sales, making payroll and other financial obligations can be stressful on budgets. However, one way to deal with fluctuating sales and cash flow problems is to see if invoice factoring is appropriate to meet year-round needs.
One way for businesses dependent on seasonal sales is to have better financial predictability and available resources, as the Journal of Accountancy explains. Businesses can accomplish this by selling their accounts receivables through factoring.
Companies looking to increase cash flow during the slow sales season can benefit by selling their accounts receivable to a third-party business called a factor. When a company sells its invoices through the factoring process, it can collect much faster on that invoice from recent customer purchases compared to Net 30, Net 60 or Net 90 when an invoice is submitted.
How the Process Works
During the course of this arrangement between a company and the factor, there are three main phases. The company receives an advance, or a portion of the invoice's outstanding balance from the factor. The difference between the portion the factor pays the company initially and the remaining portion of the invoice is called the reserve. This remaining amount is held by the factor until the invoice is completely paid off by the company's customer –more commonly referred to as the debtor.
Depending on the factor, there could be an initial invoice fee, along with an "interest charge fee," which is determined by how much is advanced from the factor's purchased invoices multiplied by the factor's interest rate and how long it takes the debtor to pay the invoice.
Accounting for Recourse and Non-Recourse Factoring
Depending on how invoices are arranged to be sold to a factor, accounting must be noted accordingly. If receivables are sold to a factor with no recourse, it should be classified as a sale on the balance sheet.
The Journal of Accountancy discusses how Generally Accepted Accounting Principles (GAAP) applies to factoring contracts with recourse. A company looking to sell its accounts receivables sells them to the factor with no stipulations attached. If an invoice transferred to the factor can’t be paid for within 90 days by the customer, the borrowing company assumes all risk for the factored invoice.
Factoring for Companies and Accounting Considerations
According to the FASB Account Standards Certification (ASC) Section 860-10-40, if receivables are sold to a factor with recourse, there are guidelines that determine if it's a sale or a secure borrowing. If the three following tests, referring to the example sale above and according to the above referenced ASC Section are satisfied, it can be accounted for as a sale.
First, if the invoices are put "beyond the reach of the transferor and its creditors" including in times of bankruptcy or if a company's assets and/or its operations are put in a legally appointed receiver, it has met the "isolation condition."
Second, the factor has the right to exchange the asset. Third, the company relinquishes control over the transferred invoices by not having an agreement the permits the company to rebuy or reclaim the accounts receivables prior to the date of maturity. The other prohibited method of control for the transferor is to have a one-sided ability to demand the transferee give back certain assets, except through a cleanup call – which is when the factoring company can make the initial company buy back the invoices before the factoring term has expired.