What Is The Process Of Business Factoring?
Business Factoring has taken place since before the 1300's
. Back then it was a means for financing sovereign debt. Today factoring has become a means for companies to have access to immediate cash they may need for investments, purchases or simply to keep their businesses operating.Basically business factoring is the process in which an organization sells its accounts receivable to another organization (called the factor) at a discount. It is not a loan; the accounts receivable are not being used as collateral for the monies. Rather, the factor is actually purchasing them. In the case of a loan, only these two parties would be involved. In the case of factoring a third party is involved- the debtor, or person who owes money on the accounts.
The process is clear and simple. The accounts are sold to the factor for immediate payment in cash. Once the accounts are signed over to the factor, the seller no longer has anything to do with them. If for some reason the debtor does not pay what they owe on the accounts, it is now the responsibility of the factor to collect these unpaid funds and to assume the costs of collection if necessary. That is why they are sold at a discount, to offset the risk of nonpaying debtors.
The determination of how much money the seller receives from the factor usually centers around three factors (no pun intended.) First, the percentage of the invoice(s) face value that the factor is willing to offer. Second, the amount of invoice value withheld as a reserve until the debtor remits payment, and lastly, a fee or service charge taken from the reserve when and if the reserve is ultimately paid back to the seller.
There are myriad reasons for selling off receivables. Some companies may have fluctuating quarterly cash flow situations. The use of factoring during those periods where cash flow is low can "even out" any spikes. Other firms, particularly in the textile industry, have demanding working capital needs (i. E. Inventory purchases.) Still other companies, who need to meet short term operational obligations, utilize factoring as a method for immediate cash infusion into the corporate coffers.
Prior to purchasing invoices and before determining what percentage of their value to pay, a factor will evaluate a seller's customers. In particular they will want to see how creditworthy these customers are. Obviously customers who have poor credit ratings are a bigger risk and may make factors weary. However, some factors will take on these invoices regardless of the credit risk. A factor will offer a lower price for these and may often take out insurance on the invoices of debtors who may not pay.
Since these accounts are being sold for less than they are actually worth, sellers should carefully decide whether the use of a factor is really the best option. They need to analyze the benefits of the immediate cash and how it compares to the loss of funds from an invoice being paid in full to them. They also need to consider the fact that their customers may be discouraged by the fact that they are being billed by an outside party. To a customer, this may look like a signal of financial trouble on the part of the company and they may therefore lose faith in doing business with them in the future.
Business factoring can prove to be a strong financial tool for many companies. As a part of a sound, responsible business strategy, it can be pivotal to success and growth.
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