Factoring definition

Factoring is a form of accounts receivable financing typically used by small businesses that have made sales to customers on 30-day terms, but needs immediate cash to pay current expenses, such as payroll, rent, utilities, etc.

When a small businesses resorts to factoring receivables it's because they are extremely under-capitalized, can't get traditional bank financing, and it's almost always an act of desperation.

Because of the tenuous financial condition of the business, and often perhaps the low quality of the receivable, the cost for such financing is very expensive, often prohibitively so. The reason is because the factoring firm, or in some cases, an individual, typically takes possession of the receivables, and then advances cash to the business after discounting the value of the receivables by a "factor" (percentage).