Factoring How does it work – Factoring is an activity in a receivables management system that facilitates a company to get cash immediately on a real-time basis.
If you like this article then please like us on Facebook so that you can get our updates in the future ……….and subscribe to our mailing list ” freely “
Quick Links
Factoring How does it work:
Factoring is an activity where a business sells its receivables to a third party (factor) against which the factor pays a certain portion say 80 to 90% of the value of the receivables immediately without waiting for a period of actual credit period granted to the customers. He will reserve the balance amount till the Realisation of receivables. Must Check Various Types of Lease.
The amount granted by the factor depends on
(1) Industry :
If the industry in which the company is engaged is of such kind where the Realisation of receivables doesn’t take considerably much time then the factor may provide up to 90% of the value of the receivables and advances at the time of purchasing them.
(2) Creditworthiness of customers :
Factor considers the creditworthiness and repayment history of the customers of the business entity to examine the probability of recovery from the receivables. If the credit history is not good then it certainly causes to lower the amount to be granted at the time of purchasing.
After realizing the debts from the receivables and advances the factor will release the reserved amount by deducting a certain portion towards his commission / factoring charges. You may also like Contingent Liability.
How it happens?
- (1) A business serves its clients or supplies its products to customers.
- (2) Gets the invoice of sale which we can refer to as receivables against a specified credit period.
- (3) The company approaches the factor and sells the receivables.
- (4) Factor pays the company a certain % of the value of the receivables (80% to 90%) immediately. And reserves the balance.
- (5) At the time maturity factor collects the debts from the customers in respect of the receivables he bought.
- (6) Factor pays the company the reserved amount after deducting a certain amount as his charges.
Types of Factoring :
(1) Notified factoring :
Here, the customer is given prior intimation about the assignment of debt
to a factor, also directed to make payments to the factor instead of to the company. This is invariably done by the company at the time of giving invoices and following the payment.
(2) Non notified factoring :
No prior intimation is given to the debtors/customers about the factoring assignment.
This kind of Factoring is common when there’s a probability that the customer may break the payment terms and factor is willing to accept the risk of collecting the amount against invoices sold to him.
(3) With recourse factoring :
Here the company itself will carry the risk of non-collection from the receivables. Here the factor is in no way responsible for the bad debts. Must Read Weighted Average Cost of Capital.
(4) Without recourse factoring :
Here the factor takes the responsibility for bad debts. If any bad debts result subsequently then the company is in no way responsible for that.
(5) Bank participation factoring :
In this, the company creates a floating charge on the
factoring reserves in favor of banks and borrows against these reserves.
(6) Export factoring :
Export factoring provides immediate financing against your export receivables. Financing can be availed in Rupees or in foreign currency. The factor buys the foreign receivables.
Recommended
