A company that sells on 60 days’ credit has the money it needs in its customers’ hands, and the customers are not in a hurry. Instead of waiting, it can turn the invoices into cash today. There are two ways. In factoring it sells the invoices (or hands the whole sales ledger) to a specialist, the factor, who advances cash, collects the money and may also bear the bad debts.
In invoice discounting it borrows against the invoices from a financier but keeps collecting the money itself, and its customers may not even know. Both are short-term finance secured on receivables, and both have a price. This topic explains how each works, the difference between factoring with and without recourse, their costs, advantages and disadvantages, and how to decide whether either is worth its cost, with a worked evaluation.
The next topic covers early settlement discounts and trade payables.
The Institute has tested the evaluation of factoring in the exam. The May Diet, 2026, Question 1(b) memorandum for a company with high receivables listed factoring and selling receivables to a finance company as a means of releasing cash, noting that it improves liquidity at a cost without reducing working capital. Read managing receivables: credit terms and credit control first.
In 30 seconds
Invoice discounting raises finance against the security of receivables without using a factor’s sales ledger service: the financier advances a percentage of the invoices, the customer pays the business, and the business repays the advance with interest and fees; it may be confidential or notified.
Factoring is the sale of receivables to a factor, who administers the sales ledger, provides short-term finance against the receivables and, if without recourse (non-recourse), also bears the bad debts. With recourse, the business keeps the credit risk. Costs: a service fee, a commission for non-recourse protection and interest on the advance. Evaluate by comparing the savings (interest, bad debts, administration) with the fees.
Invoice discounting
Invoice discounting is an arrangement in which a business uses its outstanding invoices as security to obtain an advance from a financier. It raises finance against receivables without using the sales ledger administration of a factor. It may be confidential, where the customer is not aware of the discounter, or notified.
- Submission: the business gives the invoices to the discounter.
- Advance: the discounter advances a percentage of the invoice value, less fees, and may exclude invoices of poor payers.
- Customer payment: the customer pays the business directly.
- Settlement: the business repays the advance with interest and fees.
The benefits are improved cash flow, because working capital is available at once; possibly reduced credit risk, if the financier takes some of it; and flexibility to manage fluctuations in cash flow.
Example: an invoice of ₦40m is due in 75 days. The discounter advances 85%, which is ₦34m, at an interest rate of 12% a year. After 75 days the business repays ₦34m plus interest of ₦34m × 12% × 75 ÷ 365 = ₦0.838m, a total of ₦34.838m. The customer pays ₦40m to the business, which keeps ₦40m − ₦34.838m = ₦5.162m after repaying the discounter.
Factoring
Factoring is a transaction in which a business sells its receivables to a third party, the factor. Factors are specialists who provide three main services:
- administration of the client’s sales (receivables) ledger;
- short-term finance for the client, secured on the receivables; and
- in some cases insurance against bad debts.
Factoring may be with recourse, in which the factor is not liable for the credit risk and the business bears the bad debts, or without recourse (non-recourse), in which the factor is liable for bad debts.
The process is: the business sells its invoices to the factor, the factor advances a percentage of their value, the factor collects the payment from the customer, and the factor pays the balance to the business after deducting fees and interest.
Costs, benefits and disadvantages
- Costs: a service fee for administration and collection; for non-recourse, a commission on the total receivables; and interest on the finance advanced.
- Benefits: a source of finance for receivables; lower internal administration costs because the factor runs the ledger; and credit protection (a lower cost of bad debts) under non-recourse.
- Disadvantages: interest charges are usually higher than other sources of finance; customers may think the company is weak financially or may not want to deal with a factor, which can harm the relationship.
| Feature | Factoring | Invoice discounting |
|---|---|---|
| Who runs the sales ledger | The factor | The business |
| Who collects from customers | The factor | The business |
| Customer aware | Yes, usually | Not if confidential |
| Bad debt protection | If without recourse | Not usually |
| Purpose | Finance, administration and protection | Finance only |
Evaluating a factoring offer
A company has credit sales of ₦120m a year, customers take 60 days, bad debts are 2% of sales, and it finances receivables with an overdraft at 14%. A factor offers to run the ledger for a fee of 1.5% of sales, to cut the collection period to 40 days and to advance 80% of receivables at 10%, with the balance still financed by the overdraft. The company would save administration costs of ₦1.8m a year. A 365-day year is used.
| ₦m | |
|---|---|
| Current receivables 60 ÷ 365 × 120 | 19.73 |
| Current interest at 14% | 2.76 |
| New receivables 40 ÷ 365 × 120 | 13.15 |
| Interest on advance 80% × 13.15 = 10.52 at 10% | 1.05 |
| Interest on the balance 2.63 at 14% | 0.37 |
| Interest saving (2.76 − 1.42) | 1.34 |
| Bad debts saved (2% × 120), non-recourse | 2.40 |
| Administration saved | 1.80 |
| Fee 1.5% × 120 | (1.80) |
| Net benefit, without recourse | 3.74 |
| Net benefit, with recourse (no bad debt saving) | 1.34 |
On a non-recourse basis the offer gives a net gain of ₦3.74m; on a recourse basis ₦1.34m. Both are positive. But the decision should also consider the effect on customers and the risk that the factor’s collection methods harm the relationship.
The ideas in more depth
Why the finance is cheaper than it looks, or dearer
The interest rate on the advance may be higher than the overdraft rate. But the factor also speeds collection, takes administration and may take bad debts, so the true comparison is the whole set of savings against the whole set of fees, as in the table. A quoted rate on its own is not a decision.
Why recourse matters
Under recourse the business keeps the credit risk, so a factor will advance more readily and charge less; under non-recourse the factor takes the risk and charges more, and will not take customers it considers poor risks. Factoring does not reduce the working capital invested in receivables for the business as a whole; it moves the funding, which improves liquidity.
Sources and references
- The accounting for the transfer of receivables, and whether they are removed from the statement of financial position, is governed by International Financial Reporting Standard (IFRS) 9 Financial Instruments (derecognition), which depends on whether the risks and rewards have passed to the factor.
These points are stated as at 5 November 2026.
Worked examples
Example 1: invoice discounting. An invoice of ₦40m due in 75 days; 85% advanced at 12% a year. Required: what the business keeps.
- Advance.
85% × ₦40m = ₦34m
interest ₦34m × 12% × 75 ÷ 365 = ₦0.838m. - Kept.
₦40m − ₦34.838m = ₦5.162m.
Example 2: interest on the advance. A factor advances 80% of ₦13.15m at 10%. Required: the annual interest.
- Advance.
80% × ₦13.15m = ₦10.52m. - Interest.
10% × ₦10.52m = ₦1.05m.
Example 3: with recourse. The interest saving is ₦1.34m, administration saved ₦1.8m and the fee ₦1.8m. Required: the net benefit.
- Net.
1.34 + 1.80 − 1.80 = ₦1.34m, with no bad debt saving.
How to answer in the exam
- State the basis: with or without recourse, and whether the ledger is administered.
- Cost the existing receivables and the new ones and the interest on the advance and the balance.
- List savings against fees in a table and give the net benefit for each basis.
- Add the qualitative points: customer reaction, loss of control, the signal to the market.
Common mistakes in the exam
- Including the bad debt saving when the factoring is with recourse.
- Applying the advance rate to the old receivables.
- Forgetting to finance the balance (the part not advanced).
- Confusing factoring with invoice discounting.
- Using the interest on the advance as the only cost.
- Ignoring customers’ reaction.
Quick revision
- Factoring: ledger administration, finance, optional bad-debt cover; with or without recourse.
- Invoice discounting: loan against invoices; the business collects; may be confidential.
- Costs: service fee, non-recourse commission, interest.
- Net benefit = interest saved + bad debts + administration − fees.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. Factoring is:
- A bank overdraft
- A share issue
- The sale of receivables to a factor, who may administer the ledger and give finance
- A tax
Show the answer
C. It speeds the receipt of funds from receivables.
Question 2. In non-recourse factoring:
- The business bears bad debts
- The factor bears bad debts
- The customer bears bad debts
- No one bears bad debts
Show the answer
B. The factor is liable for the credit risk.
Question 3. In invoice discounting:
- The customer pays the business, which repays the discounter
- The discounter runs the sales ledger
- The customer pays the discounter only
- The invoices are written off
Show the answer
A. It is a loan against invoices.
Question 4. The three main services of a factor are:
- Audit, tax and legal
- Marketing, sales and design
- Hedging, leasing and banking
- Ledger administration, short-term finance and bad-debt insurance
Show the answer
D. The insurance is available in some cases.
Question 5. With recourse, the credit risk is borne by:
- The factor
- The business
- The government
- The bank
Show the answer
B. The factor is not liable for bad debts.
Question 6. A disadvantage of factoring is that:
- Interest is usually higher than other finance and customers may see it as a sign of weakness
- It lowers cash
- It raises administration costs
- It is illegal
Show the answer
A. Some customers do not want to deal with a factor.
Question 7. Confidential invoice discounting means that:
- The invoices are not real
- The factor collects the money
- The customer is aware of the discounter
- The customer is not aware of the discounter
Show the answer
D. Contrast with notified discounting.
Question 8. A benefit of factoring is:
- Higher internal administration costs
- Reduced internal administration costs
- No fees
- No interest
Show the answer
B. The factor runs the receivables ledger.
Question 9. The costs of factoring include:
- Only interest
- Only a commission
- A service fee, a commission for non-recourse and interest on advances
- Nothing
Show the answer
C. All three may be charged.
Question 10. In the factoring process, the factor settles the balance with the business:
- After deducting fees and interest
- Before collecting
- Without any deduction
- Only if there are bad debts
Show the answer
A. After collecting from the customer.
Section B style: written questions
Question 11 (10 marks). (a) Distinguish between factoring and invoice discounting. (4 marks) (b) Distinguish between recourse and non-recourse factoring. (3 marks) (c) State THREE costs of factoring. (3 marks)
Question 12 (15 marks). A ₦10m invoice is due in 90 days. A discounter advances 80% at 12% a year. (a) Calculate the advance. (3 marks) (b) Calculate the interest for 90 days. (4 marks) (c) Calculate the amount the business keeps when the customer pays. (4 marks) (d) State TWO benefits of invoice discounting. (4 marks)
A further written question
Question 13 (20 marks). A company has credit sales of ₦80m, customers take 75 days and bad debts are 3% of sales. It finances receivables at 13%. A factor offers non-recourse factoring for a fee of 2% of sales, with collection in 45 days, an advance of 85% at 9%, the balance financed at 13%, and an administration saving of ₦1.2m. Use 365 days.
(a) Calculate the current receivables and their financing cost. (4 marks) (b) Calculate the new receivables and the new financing cost. (6 marks) (c) Calculate the net benefit without recourse and with recourse. (6 marks) (d) State TWO non-financial factors. (4 marks)
Model answers
Show the model answer to Question 11
(a) In factoring the business sells receivables to a factor who administers the ledger, collects and finances (2). In invoice discounting the business borrows against invoices and keeps collecting from customers, possibly confidentially (2).
(b) Without recourse the factor bears bad debts (1.5); with recourse the business bears them (1.5).
(c) A service fee; a commission for non-recourse protection; interest on the finance advanced (1 each).
Show the model answer to Question 12
(a) 80% × ₦10m = ₦8m (3).
(b) ₦8m × 12% × 90 ÷ 365 = ₦0.237m (4).
(c) ₦10m − ₦8m − ₦0.237m = ₦1.763m (4).
(d) (2 marks each) Immediate access to working capital; flexibility in managing cash flow fluctuations; possibly less credit risk.
Show the model answer to Question 13
(a)
- Receivables 75 ÷ 365 × ₦80m = ₦16.44m (2)
- cost 13% × ₦16.44m = ₦2.14m (2).
(b) New receivables 45 ÷ 365 × ₦80m = ₦9.86m (2); advance 85% = ₦8.38m at 9% = ₦0.75m (2); balance ₦1.48m at 13% = ₦0.19m (1); total ₦0.95m (1).
(c)
- Interest saving ₦2.14m − ₦0.95m = ₦1.19m.
- Without recourse.
1.19 + bad debts 2.40 + administration 1.20 − fee 1.60 = ₦3.19m (3). - With recourse.
1.19 + 1.20 − 1.60 = ₦0.79m (3).
(d) (2 marks each, any two) The reaction of customers to a factor collecting; loss of control over credit decisions; the signal to the market about the company’s finances; the factor may refuse poor-risk customers.
Pathfinder on Debt factoring and invoice discounting
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
The memorandum in part (b) (15 marks) lists factoring and the sale of receivables to a finance company as ways to release cash, improving liquidity at a cost without actually reducing working capital.
Revise first: Factoring
Source: ICAN Pathfinder, Financial Management. Diets covered: Every diet in the Pathfinder, November Diet, 2025 and May Diet, 2026, was reviewed here. The diets listed above test this topic directly..
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