A general contractor is experiencing cash flow problems and considering factoring receivables. Which statement best describes this financing option?
Correct Answer
D) Selling receivables to a third party at a discount for immediate cash
Factoring involves selling accounts receivable to a factor (third party) at a discount in exchange for immediate cash, transferring ownership of the receivables.
Why This Is the Correct Answer
Factoring receivables means selling accounts receivable to a third party (the 'factor') at a discount in exchange for immediate cash. Ownership of the receivable transfers to the factor, who then collects payment directly from the contractor's clients. The contractor receives less than face value but gains immediate liquidity — useful for bridging cash flow gaps between billing and payment cycles on construction projects.
Why the Other Options Are Wrong
Option A: Using a line of credit secured by accounts receivable
Using a line of credit secured by accounts receivable describes asset-based lending (ABL), not factoring. In ABL, the receivables serve as collateral for a loan, but the contractor retains ownership of the receivables and repays the loan as cash flows in. This is fundamentally different from factoring, where ownership is transferred.
Option B: Borrowing money using receivables as collateral while retaining ownership
Borrowing money using receivables as collateral while retaining ownership also describes a secured loan or revolving credit facility — not factoring. The key distinction of factoring is the transfer of ownership: the contractor no longer owns the receivable after factoring.
Option C: Extending payment terms with suppliers to improve cash flow
Extending payment terms with suppliers to improve cash flow describes a payables management strategy (stretching accounts payable), not factoring. This is a liability-side approach to cash flow management and has nothing to do with accounts receivable.
Memory Technique
FACTOR = sell For A Cut To Obtain Revenue. The factor buys your invoices at a cut (discount) and you get the cash now. You no longer own those invoices — the factor does. Think: a factoring company is like a bill collector who bought your debt at a discount.
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