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Factoring: How Does Factoring Work?

Factoring is a service where a company sells its receivables or invoices to a third party called a factor at a discount. The factor then takes on the credit risk and handles collecting payment from customers, freeing up working capital for the company. Factoring transactions can be done with or without recourse, where with recourse the factor can demand payment from the company if a customer does not pay, while without recourse the factor assumes the loss. Factoring provides benefits like immediate cash flow, lower costs than alternatives like loans, and professional management of credit and collections.

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42 views2 pages

Factoring: How Does Factoring Work?

Factoring is a service where a company sells its receivables or invoices to a third party called a factor at a discount. The factor then takes on the credit risk and handles collecting payment from customers, freeing up working capital for the company. Factoring transactions can be done with or without recourse, where with recourse the factor can demand payment from the company if a customer does not pay, while without recourse the factor assumes the loss. Factoring provides benefits like immediate cash flow, lower costs than alternatives like loans, and professional management of credit and collections.

Uploaded by

Anand Mishra
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Factoring

Factoring is a package of services providing integrated receivables management. The receivables of a company are purchased by an entity called factor. Factor is an agent who does things for his client for a consideration called commission.

How does Factoring work?


A factoring agent buys a companys receivables and gives the company cash at a discount. Under recourse method of factoring, the factor can come back to the person who employed him and ask to money, if he is unable to collect it from the client. Under non-recourse factoring, it is not possible. The factor assumes the loss on account of bad debt in non-recourse factoring. Factoring is the realization of credit sales. Maximum debt period under factoring is 150 days. Factor 6

4 3

1 The person who hired factor (seller) 1-customer places an order 2-seller moves the load

5 Customer

3-seller sends invoice to factor (in some case seller also sends a copy of invoice to customer) 4-Factor pays him cash up to 90-95% (varies with each factoring company) against the invoice 5-Factor mails the invoice to customer 6-Customer pays the factor

Functions of Factor
Assumption of credit risk (if factoring is done without recourse, the factor cannot come back to the seller) Maintenance of Sales Ledger (customer invoice against customer receipts) Collection of account receivables (Factor has trained manpower and well-equipped infrastructure for collection of receivables) Financing trade debts- Factor gives maximum advance equal to the amount of factored receivables after deducting o Factoring commission o Interest on advance

o Reserve to cover bad debt loss Credit Analysis of customer

Benefits of factoring
Benefits are discussed mainly with respect to the person who employs the factor. Some are: Immediate increase in cash flow Less Cost (Cost is less compared to the amount that could have been lost, had factor not been employed) Professional collections Source of finance Credit Screening

Type of Factoring
Recourse and Non-recourse factoring Disclosed and undisclosed factoring Domestic and International factoring

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