Factoring is a word often misused synonymously with accounts receivable financing. Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables, not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of an asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

The three parties directly involved are: the seller, debtor, and the factor. The seller is owed money (usually for work performed or goods sold) by the second party, the debtor. The seller then sells one or more of its invoices at a discount to the third party, the specialized financial organization (aka the factor) to obtain cash. The debtor then directly pays the factor the full value of the invoice.

Reason why companies do this:

A company sells its invoices at a discount because it is more profitable for them to use the funds (from selling the invoices) to support their sales growth than "to be their customer's bank". This means that the seller can make more money from investing in their growth than from supporting their customer’s business by extending them credit for sixty or ninety days (for example).

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