Factoring is the process by which a financial institution (factor) purchases a business’s invoices at a discount. The factoring company then undertakes the responsibility for collecting invoices due from the business’ customers. The factor also accepts any credit risk attached to them.
Factoring usually pay a certain percentage of the invoice amount to the company as advance. The balance minus the charges is paid after collecting the accounts receivable from the customer. Factors earn a profit by advancing less cash than the actual value of the accounts receivable.
Factoring can be used by any company that deals in products or services on credit terms.
Factoring is also referred to as receivables factoring, invoice factoring, bill factoring, accounts receivable factoring and factoring invoice discounting.
1. Factoring helps cut down bad debts and improves receivable collections. Factoring removes the uncertainty element.
2. Factoring facilitates simple and quick funding for your outstanding receivables within 24 hours or less.
3. Factoring speeds up cash flows and helps improve credit rating. Immediate cash not only improves liquidity but also helps expand a business.
4. Factoring provides a business with the much-needed working capital or funding.
5. You can benefit from early pay and volume discounts. Major suppliers can be paid quickly.
6. You can borrow money from the bank, secured by your debt.
7. Factoring saves a company the bother of time-consuming billing cycles and the stress of debt collection. The company can concentrate on meeting the growing needs of its business.
8. Factors maintain your sales ledger, which reduces your administration costs.
9. Better credFactoring facilities can be offered to new and larger customers and hence generate more business and boost sales.
10. No additional debt is incurred enabling you to retain your financial advantage to take on new debt.
11. You can allocate critical resources to key areas.
12. There is no personal liability or obligation.
13. You can meet tax requirements, disburse employee payrolls and execute new orders.
14. Factoring helps establish the credit worthiness of a customer by studying payment records before the company does business with them.
15. There are no set limits as the factoring line is directly linked with sales growth. The more you sell, the more is the finance available.
16. Credit monitoring and feedback by factors helps detect customer service problems.
17. Detailed management reports help track a customer’s financial well-being.
18. Debt collection is handled by experienced professionals, who can skillfully effect collections.
Factoring facility has two main costs:
It is denoted as a percentage of turnover (ranging between 0.5% and 3%). The actual charge is dependent on a number of factors like customer size and number of invoices. A nominal annual fee is also levied.
It is expressed as a percentage over bank base rate (ranging between 1.5% and 3.5% over base) and is the cost of borrowing money.
Factoring with recourse:
In recourse factoring, the factor manages the sales ledger and debt collection with the client being accountable for non-payment by the customer. The factor does not assume the risk of insolvency at the time of invoice purchase. Since the factor takes on minimal risk, the factoring fees are low.
Factoring without recourse:
In non-recourse factoring, the factor takes on the responsibility for maintaining the sales ledger and the collection of debts. In case of non-payment by the customer, the factor is liable for the losses. Since the risk attached is higher for the factoring company, the factoring fees are also higher.
In this form of factoring, the client keeps responsibility for the administration of the sales ledger, credit control and collection of invoices, although the customer is cognizant of the factoring agreement and payments are made directly to the factor.
Overall, a factoring company can be the ideal business partner, providing you with the required financial support and expertise to succeed.