Plain definition
Factoring is a receivables-financing arrangement in which a business assigns customer invoices to a factor that typically also manages collection. An advance may provide cash before the customer pays. The agreement determines the fees, retained amount, collection responsibilities, and treatment of unpaid invoices.
The crucial distinction is recourse: whether the factor can recover an unpaid advance from the business. A non-recourse label does not necessarily cover every dispute, return, fraud, or breach of contract.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
Suppose a wholesaler assigns a invoice and receives an advance of . The customer later refuses payment because part of the delivery was defective. The factoring agreement leaves commercial disputes with the wholesaler, so the factor can require it to repay the advance under the agreed terms.
The company received cash earlier, but did not transfer responsibility for delivering the correct goods. It must resolve the dispute and plan for the possible repayment.
Why it matters
A founder may assume that handing over collections also hands over every credit and delivery risk. That assumption can turn a useful working-capital service into an unexpected repayment obligation.
Practical consequence
Check the recourse provisions, dispute exclusions, fees, settlement dates, and customer-notification process before assigning invoices. Agree how complaints reach the sales team and who follows them up. Reconcile advances and retained balances to customer receipts, and track disputed invoices separately from simple late payments.