What is financial factoring?

The financial factoring, accounts receivable factoring or debtor financing, is when a company buys a debt or invoice from another company. Factoring is also seen as a form of invoice discounting in many markets and is very similar but only within a different context.

In this purchase, the accounts receivable they are discounted to allow the buyer to make a profit on paying off the debt. Essentially, factoring transfers ownership of the accounts to another party who then pursues the debt.

Therefore, this relieves the first party of a debt for less than the full amount, providing you with working capital to continue trading, while the buyer, or factor, pursues the debt for the full amount and the profits when pay.

I know requires factor to pay additional fees, usually a small percentage, once the debt has been paid off. The factor may also offer a discount to the indebted party.

Factoring is a very common method used by exporters to help speed up their cash flow. The process allows the exporter to extract up to 80% of the value of the sales invoice at the point of delivery of the merchandise and when the sales invoice is raised.

Components of Financial Factoring

Financial factoring works with three parts. The seller is the person who sells the receivable. The account receivable is an asset, as it is the amount owed to the seller for goods sold or services rendered.

The third is an organization interested in purchasing the accounts receivable at a discount from the seller and paying in cash. The seller transfers his ownership rights to the receivable to a third party, and the latter also ends the risk involved in the event of non-payment of installments.

Factoring consists of three components in the financial transaction. These are:

• Advance- This is a certain percentage of the face value of the invoice, which is paid to the seller when he presents them for sale.
• Reservation: this is the amount that is kept until the debtor makes the payment of the invoice.
• Position- This is the amount charged by the factor as the cost of the transaction, and is deducted from the reserve and paid at the end upon receipt from the debtor.

The factor takes into account the risk involved in the case of non-payment by the debtor and takes it into account when deciding the amount to be given to the seller.

Factoring main features

Factoring it is not a loanbut a sale of business invoices. It falls under the same category of financial instruments as invoice loss and discounting, all of which allow small businesses to raise funds.

It involves the sale of all accounts receivable from the business and is a business-based operation. On the other hand, the loss involves the sale of only one of your transactions and is therefore considered a transaction-based exercise that has no connection to the other transactions.

Similarly, the invoice discount It is clearly different from factoring in that it is similar to a loan in which the account receivable is used as collateral.

Other main characteristics of factoring are:

• The factoring period generally ranges from 90 to 150 days.
• It is an expensive method of short-term borrowing.
• Appropriate for new companies without credit history, since it is granted based on the creditworthiness of the company's clients and their ability to pay off their installments.
• The factor always performs due diligence and a credit risk analysis before providing funds for the small business.
• Factoring can be disclosed or undisclosed, with recourse or without recourse.
• Many companies offer factoring facilities to businesses.
• Although expensive compared to other types of small business financial instruments, the factoring is often used to obtain immediate cash to keep the business in functioning.

Advantages of financial factoring

Factoring offers the advantage of get quick cash, secures business debts, reduces risk of bad debts, and helps ensure smooth cash flow. Factoring in turn makes money as it buys accounts receivable at a discount.

On the other hand, it provides immediate cash. Well, the most important benefit of factoring is that it provides your business with immediate cash. This financing should help fix your cash flow and give you resources to pay your expenses and hire new clients.

One of the main challenges of offering payment terms is trying to determine the creditworthiness of your business customers. Most factoring plans include customer credit reviews as part of your solution. This feature allows you to outsource this important task to the experts.

It is also easier to obtain than most solutions. The main requirement is that you have invoices for work delivered by creditworthy clients. Other than that, your business should be free from liens and legal hassles.

The lines are tied to your invoice balance. So they can easily go up as long as your bills go up and your customers' credit quality remains good. This feature makes invoice factoring an ideal solution for companies experiencing a aggressive growth stage and in need of financing that can keep up with the level of increase.

Disadvantages

As disadvantages on the part of factoring, there are some, which are:

• It costs more than a line of credit or financial solutions offered by the bank.
• You solve only one problem. That is, although loans and lines of credit can often be used for a number of things, factoring solve only one problem: the cash flow shortfall due to slow paying customers. So it can be one-dimensional and should be used only to solve that problem.
• Finally, while factoring companies are good at limiting bad debts, there is still a chance that some bills will go unpaid. Factoring companies are not collection agencies and they do not behave like collection agencies. This point is very important. Bad debt will return to your business so you can assign it to a lawyer or collection company