This is a financial transaction which will sell the invoices to a factor that is a third party. This is called as factoring. Factoring basically a financial transaction .For factoring the exchange takes place at a discounted rate in order to get money quickly so that it will help in the development of business. This is entirely a new concept while compared to a bank loan. Factoring can be differentiated with bank loan in there different ways. First one is on the value of financial asset and not on the credit worthiness. The main thing to be noted with this is that this is not a loan. Factoring is purchasing a financial asset. If comparing Factoring system to a bank loan we can see that there are two parties that is borrower and receiver of the loan, but in factoring there is the presence of three parties.
So factoring involves sale of a portion of the firms or companies receivables. Factoring is always a misled term. Usually this term is confused or misused with the term invoice discounting. Invoice discounting is just borrowing and the received is used as the collateral. The three parties involved in factoring are:
The receivable which will always be the financial asset linked with the debtor’s liability which is used to pay the money to be paid to the seller. The seller in turn sells the invoice at a discounted rate to a third party. Third parties will be a particular monetary organization to get cash. Once the sale takes place the factor gets full ownership along with the risks and the rights associated with it. If the debtor does not pay the amount the factor will have to bear the loss. For factoring there are three main principles to be checked during transaction which is given below:
Factors sometimes charge the seller a service charge. Along with this an interest also is there depending upon the waiting for the repayment from debtor. The profit which the factor will get is from the difference of price paid for the invoice and cash got from the receiver.
So factoring can be termed as an alternative for management of receivables. In layman’s language it’s the translation of credit sales in to cash. The amount received in factoring can be for services offered or for the product.