A financing method in which a Financier buys debt or invoice from another company, so basically seller surrenders accounts receivable at a discount to a factor (Financer) to raise capital. Upto 80% of account receivables can be discounted with factoring services. The biggest advantage of Factoring is that it is an out-of-balance sheet product and it does not create liability on balance sheet.
So a Factor is :-
A Financial Intermediary
Buys invoice/book debts
Take responsibility of collection of payments
Financial Institution ( Lender)
Types of Factoring:
Recourse Factoring:- Factoring with recourse, as the name suggests. In case of non payment of invoice, liability of paying of discounted amount from Factor will still be with the seller.
Non Recourse Factoring :- Under this facility, Factor not only discounts bills, but also provides guaranteed credit protection. In case of non payment, Factor will bear the risk of bad debts.
Maturity Factoring:- In Maturity Factoring, the Factor agrees to pay amount to exporter/seller on the agreed date.
Cross Border Factoring: - Also referred to as two Factor system of factoring, it is almost similar to domestic factoring, except that 4 parties are involved. They are:
Client (Exporter) enters into arrangement with Export factor in his country & delegates export receivables to him. Export Factors enters into arrangement with Import Factor & organises for credit evaluation & collection of payment for an agreed fee.
Import factor collects payment from Importer and remits it to export factor , which in turn passes credit to exporter.
Advantage of Factoring:
1. Factoring helps to improve the current ratio, which in turn adds liquidity to the company. This reduces working capital cycle gap. Seller therefore can offer better credit terms and increase orders.
2. Increase in the turnover of stocks. Since the cash recovery is fast, overall topline of company increases.
3. It ensures prompt payment and reduction in debt.
4. It helps with credit protection.
5. Reduces work of collection/recovery department.Responsibility of collecting the dues solely lies with ‘Factor’/Financer.
Commission/Fees of 0.5-1.5% for rendering factoring services
Interest Cost for discounting is charged for the specified tenor debt receivable usually varies between 10-12%.
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