Factoring is a potentially dangerous and often misunderstood financing tool. Factoring is where you sell your receivables to a finance company in exchange for immediate cash. The goal is to speed up cash receipts when loans are either undesirable or unobtainable. If you can make use of cash to generate large returns quickly, but the receivables come in slowly, or if you don't have the staff to keep up with lengthy installment payments, then factoring may be useful for you.

There are two basic types of factoring that factoring companies offer. Recourse means that while you sell the receivables, you are liable for any uncollectible amounts. The factoring company simply does the paperwork of collecting it for you, and advances you the expected net receivable amount. The other type is non-recourse. With non-recourse you are selling the receivable, but are not liable for any losses the factoring company may suffer due to uncollectible amounts.

With both types of factoring, the factoring company will want you to perform a credit check first before they will accept a new receivable. In addition, they may withhold a portion of the receivable as a "deposit" against future losses. This reserve can usually be tapped only when you close out the factoring account, although occasionally you may be able to renegotiate the deposit requirement based upon a favorable collections experience.