Try this approach to simplify your accounting process for recording invoice factoring
Handling the bookkeeping of factored sales invoices is not overly complex. However, some accounting systems may complicate the process. And, if you have never recorded the various transactions associated with invoice factoring, the accounting can seem more complex than it is in reality.
The following is not the only way to record factored sales invoice transactions. And some accounting software packages may require a slightly different approach. Still, this guide will give you a basic understanding of the accounting entries required.
What is Sales Invoice Factoring?
Sometimes called accounts receivable financing, sales invoice factoring is an off-balance sheet financial product that businesses can use to fund a shortage in their working capital.
When a company factors a sales invoice, the factoring company purchases the invoices from the issuing company offering an advance percentage ranging from 80 – 95%. The issuing company will receive, usually within 24 hours, the face value of the sales invoice, less the factoring fee or rate and less a small retention percentage. The retained amount will be paid in full when the company’s customer settles the invoice.
When the factoring company pays the issuing company, the ownership of the debt is passed to the factor. In other words, the customer now owes the factoring company, not the issuing company. This change of ownership is why factored sales invoices will usually have notice of assignment printed on them.
Factoring is not treated as a loan because the sales invoice is purchased rather than money being lent. So, there is no immediate liability to be recorded in the books of the issuing company. And, that lack of liability is why factoring is known as off-balance-sheet financing.
Related: How Invoice Factoring Can Solve Your Cash Flow Problems
Accounting for the Sales Invoice
The first transaction to be recorded will be the raising of the sales invoice. In the first instance, this transaction will be recorded in the same ways as usual. You raise the sales invoice in your accounting system to the customer, crediting an income account general ledger account, and debiting the customer account in the accounts receivable (AR).
The customer will not be the party paying the sales invoice. However, initially posting the invoice through the accounts receivable will maintain a sales history for each customer. It may also be necessary for updating inventory records. It is also likely that the only place you can print a sales invoice in your accounting system is the accounts receivable module.
Transferring the Debt to the Factoring Company
At the end of each day, the issuing company will send the factoring company a schedule of invoices raised and copy invoices. The factoring company will then process that day’s invoices for payment.
In most cases, the factoring company will finance all the invoices you send them. But in some instances, the factor may query an invoice. So, it is best to delay moving to the next step until you have received payment confirmation from the factoring company.
Once you have received confirmation, you can transfer the debt from your customer’s accounts receivable account to a factoring control account. This transfer is best achieved in most accounting systems by setting up the factor control account as a bank account and processing an AR receipt to that account. The control will need to be a bank account because most systems will only allow a cash receipt to be debited to a bank account in the general ledger.
The accounting effect of this transaction is to credit accounts receivable and debit the factor control account. So, now the books show that the factoring company owes the value of the sales invoices to issuing company.
Related: 10 Considerations When Selecting the Best Factoring Company for Your Business
Accounting for the Cash Receipt from the Factoring Company
The next stage is that you will receive the cash from the factoring company. The money you will receive will be the total of the face value of the invoices approved, less the financing fee and less the retention.
This cash receipt will usually be processed through the accounting system’s non-AR cash receipt function. The double entry for this transaction will be; Debit the bank with the cash received. Debit the factoring fees account in the profit and loss account with the finance charge. And debit a factoring retentions control account, a debtor account in the balance sheet, with the balance retained by the factoring company. The other side of this entry will be the total of the sales invoice, which will be credited to the factor control account.
Accounting for the Payment of the Retention Amount
Once a customer has settled a sales invoice, the factoring company will release the retention amount. This transaction can be recorded as a non-AR cash receipt, debiting the bank and crediting the factoring retentions control account.
Accounting for Recourse Sales Invoices
There are two types of factoring arrangements; recourse and non-recourse. The most common type is recourse factoring, which means that the issuing company must buy back any unpaid sales invoices from the factor. In a non-recourse agreement, the factor bears the cost of most, but not necessarily all, types of unpaid invoices. In any event, the accounting treatment of recourse invoices is the same.
To account for a recourse invoice, you must reverse the previous factoring bookkeeping entries for that invoice. So, the cash receipt posted to the customer AR account must be reversed, and the accounts receivable invoice reinstated. Reversing the receipt will debit accounts receivable and credit the factor control account. The amount of the recursed invoice less the retention will usually be deducted from the next payment you receive from the factoring company.
Related: Nine Common Misconceptions About Invoice Factoring
The Bottom Line
The above accounting treatment will work with most accounting software packages. And this approach is probably the simplest way to record the transactions. Some accounting packages, however, have specific functionality to record factored sales invoices. In which case, the resulting double entry will be the same or similar, but the mechanics may differ. If you use QuickBooks, you can find our three-step process to record invoice factoring here.
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Whether your business is thriving and you can’t keep up, or you are waiting on clients to pay, Universal Funding can help your growing company. Call us at 800.405.6035 or complete our rate form today to learn more about invoice factoring and how it can improve your company’s cash flow.
About Universal Funding
Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.
