Business factoring is a business selling accounts receivable at a reduced price so it can use the money for business. Factoring is different from bank loans because it sells receivables. You do not need to apply for a loan. Lastly, there are three parties to the transaction while in a bank loan, only two.
Business factoring companies basically offer debt collection in behalf of seller company and do ledger management. Businesses use factoring to be able increase cash flow. It can also effective in lowering administration expenses. Businesses who do factoring are called factors or factoring companies.
Factoring is composed of three groups: the seller, debtor and the factor. What the seller sells are not products or services but the accounts receivables of his company. The receivable is a financial document considered an asset which serves as proof that a customer or client owes money to a seller. The debt comes from the trading of services or goods.
The seller sells invoices to a factoring company. The invoice is sold often at a lower price. The factoring firm pays reduced amount than its face value. Once the agreement is signed, the receivables are now owned by a factoring firm. Consequently, a factor will shoulder the accompanying risks and responsibilities on the receivables. Non-payment of debtor means the factor will absorb the loss.
Factoring is mistaken as invoice discounting at times. These two vary. Factoring involves selling of receivables while invoice discounting merely uses the receivable as collateral for a loan. The biggest difference is that the former is a sale; the latter is a loan.
Factoring is also erroneously called forfeiting. These two business transactions vary in the nature of their transaction. Forfeiting is transaction based while factoring is company based. In forfeiting, the company sells a specific business deal. In factoring, the firm sells accounts receivables or invoices.
In case of a factor transaction with notification, factoring company informs the debtor that the receivable is sold to them. This factor will be the one to bill the debtor and receives payments. In a factoring transaction using notification basis, a seller is never allowed to receive payment from the debtor. If he does, he might not be able to make advances from factor.
In a factoring transaction is made up of three important parts. First, the money advances made by the seller. The advances is the discounted amount of the receivables paid to the seller. Second, the reserve. This the amount withhold by the factor until full payment of receivable is made. Lastly, the transaction fees. This is the amount deducted to the reserve before the factor pay the seller in full.
In business factoring, the factor could deduct service charges from the reserve. He is also allowed to deduct interest charges depending on the agreement made. Interest charges are determined by the length of time it takes to be able to collect the payments from accounts receivables.
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