Factoring can be defined as the discounted selling of receivable accounts by the owner of the business to another party for the purpose of raising funds or to source capital. The third-party in the business transaction is the one termed as the factor. Factoring is among the oldest types of financing a business. It is used as a tool for cash management for several companies. It is widespread in some industries like the clothing sector and where the business cycle involves long receivables. Although it is considered an expensive method of financing, the method has still managed to become more popular over the years.
What Does Factoring Involve?
Factoring is used as a short-term method of financing for most companies. This is because most companies use it for a maximum of two years. The process starts when the business owner sells, delivers the service or product and comes up with an invoice. The business owner then delivers the invoice to the third party. Afterwards, the factor verifies the invoice.
The factor or the third business party ideally purchase the permission to collect anything on the invoice. Additionally, the factor should agree to pay the business owner a 75 - 80 percent of the total value on the spot. The third party waits for the client to deliver the payment. The remainder of the value indicated is paid when the customer pays and the factor deducts the required fee. Most companies that factor are usually apprehensive about the client’s paying ability and not their financial capability.
Factoring also has more advantages than a traditional bank loan. This is because the method provides services that traditional banks do not. These services include producing financial reports that will inform you about your position in a business, assisting with checking credits and doing the accounting for their customers.
Categories of Factorin
Factoring is divided into several categories; these categories exist because of the many functions that the financial method involves. The types include the following:
- Undisclosed and Disclosed factoring
- Non-recourse and recourse factoring
- Cross-border and domestic factoring
- Maturity and advance factoring
- Full factoring