A merchant gets paid by the host bank before its customer gets around to paying the bill, and the bank takes a percentage of the customer's payment. When the factor purchases the value of the receivable, it takes the credit risk that the invoice will be paid, while the client retains the performance warranty on the work done for a customer. The factor usually performs a credit check on the customer before deciding to purchase the receivable. When a factor makes a loan against an invoice which typically occurs when customer credit is not favorable its client continues to assume the credit risk, and will be liable for non-payment. Since the factor often helps provide financial discipline and for its clients, it isn't uncommon for a bank to recommend a factor to a client seeking a loan without the adequate credit record.
Banks see factoring as an interim solution to inadequate credit.
Factoring allows companies the opportunity to secure short-term working capital to get them in a better position to secure a banking relationship. A company which cannot establish an exemplary credit history can eventually become a bad risk for any financial partner. The factor's ideal partnership would be with a new or reorganized company with a bright future one which probably won't include depending on a factor for more than a few years. The perception of the factor as the last line in a shaky financial defense has persisted largely because of the unregulated status of the factoring industry. Some factors are private individuals with huge cash bankrolls, while others are public companies accountable to shareholders.