subject: A Brief Summary Of Information About Business Factoring Transactions [print this page] Business factoring is the sale of a financial asset belonging to a company to a third party. The reason for this transaction is the acquisition of cash flow. This enables the business to continue to trade in a cash rich way. This type of business method is chosen by a company for two reasons. The first is that the firm does not have to have a credit check undertaken, the transaction is based purely on the value of the asset. The second is that instead of acquiring a loan, the company sells an asset. A factoring transaction involves three legal people, the owner of the asset e. G. An invoice, the debtor, the person who owes the debt, and the factor, the third party.
Factoring and a method called forfaiting are often confused. However factoring is the sale of all of the receivables whereas in forfaiting, only a part of the receivable is sold. Factoring is also used when the practice of discounting invoices is used but this term is coined erroneously. I it involves loaning the money from a third company and using the asset as collateral.
There are three parties associated with factoring as mentioned. They are the seller of the asset, the debtor and the third party who is buying the asset, called the factor. The asset is usually an invoice which has been issued as a result of services rendered or through the acceptance of a product. This asset is then sold to the third party for a fee less than the face value of the asset itself. The advantage of this is that the seller then receives an instant cash payment from the third party for the asset.
When the factor has received all the rights of the asset, they are able to receive all payments made by the debtor thereafter. The debtor will be informed that the third party now holds the debt and that they are responsible for collecting and billing it. If the debtor is unable to pay the debt then the third party will incur the losses arising form it.
After the sale of the asset to the third party, the seller should never collect the payments made by the account debtor. If they do, they could potentially become liable to the loss of additional advances from the factor.
There are three components to every business factor transaction. The advance is the down payment made to seller after the agreement of the deal to transfer the asset to the third party, this is usually a small percentage of the total value of the asset.
The second part is the reserve. This totals the remainder of the asset which is held until the payment of the asset is made by the debtor.
The third is the fee, the fee occurs from the costs involved with the factor retrieving the money from the debtor. The fees incurred will be subtracted from the debt repaid to the seller.
It is not uncommon in business factoring for the factor to charge the seller a service charge. Such charge could also be demanded regardless of whether the seller has paid interest to the factor if the factor has had to wait for payments from the debtor.
