subject: Know The Basics Of Factoring [print this page] In this changing financial landscape, factoring is a regular practice for many businesses. To generate capital, the company sells its invoices to a third party at a discount. The party generating funds buys the invoices and agrees to pay the amount after deducting the discount on the face value of the invoice.
What is Factoring
Factoring is a preferred alternative for businesses that seek improved cash flow; however it is being increasingly used to reduce administration overheads. All those businesses that offer this service are known as debt factoring companies or factors. Financial institutions such as individual brokers and banks provide funding on the basis of the values of the accounts receivable of the borrower. As factors offer credit to the customers of their clients they are more concerned about the former's ability to pay rather than the latter's financial status. Thus any business having creditworthy customers can expect itself eligible for factoring even if it doesn't qualify for a loan.
Factoring should not be considered a loan; rather, it is the sale of an asset and does not in any way create a liability on the encumbered assets. Factors help their clients with credit checks and take over a major part of their accounting work generating financial reports for them to let them know where they stand. In situations when you can't qualify for a loan factoring is a boon in disguise.
Features of Factoring
In developed financial markets the factor has no claim against the client, who is the borrower, in the event of default. In less-mature markets factoring is done on a non-recourse basis under which the factor has a claim against the client for deficiency of purchased receivables. In that case the factor suffers loss if the underlying accounts are unpaid and the client cannot cover the deficiency.
In the case of recourse factoring the client would be liable to pay off all the debts if the customer defaults with only little risk to the factoring company. As part of the risk management factors impose concentration limits and credit risks to restrict the funding of borrowers.
Factoring with recourse may involve notifying the debtors whereas factoring without recourse may not include notification. All in all, a factor offers three services including assuming credit risk, financing and a collection service which involves collection of non-performing accounts and current accounts to help the client or borrower to reduce losses associated with bad debts.
Even though factors take responsibility of the whole amount of receivables they usually do not pay 100% of the face value (Typically 80%) keeping the difference in the amount as a reserve to cover any deficiencies in the payment of invoices.
