alleryStart learning →What happens to a firm's accounts receivable in factoring?
AThey are sold outright at a discount
BThey are pledged while the firm keeps them
CThey are bought back from its own customers
DThey are converted into shares of common stock
Answer & Solution
Correct answer: A. They are sold outright at a discount
1. In factoring, a firm sells its accounts receivable outright to a factor.
2. The factor is a financial institution, often a commercial bank or commercial finance company, that buys receivables at a discount.
3. Because the sale is outright, ownership passes to the factor rather than the receivables merely being pledged.
4. Factoring is more expensive than a bank loan, precisely because the factor buys the receivables below their actual value.
5. It is widely used in the clothing, furniture and appliance industries.
6. Pledging receivables while keeping them describes the other route, a secured loan backed by receivables as collateral.
_Source: OpenStax Introduction to Business (CC BY 4.0), Ch 16 "Understanding Financial Management and Securities Markets", section 16.3 Obtaining Short-Term Financing_
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