The Disadvantages of Factoring Receivables
Factoring receivables is a process in which companies can sell their accounts receivable (A/R) balances at a discount for cash. Businesses that do not want to manage or collect their A/R balances can receive a discounted amount in cash from a factoring company for qualified receivables. Although factoring receivables can be a good source of cash, it does have several disadvantages.
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The Facts
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Businesses use A/R factoring to gain quick access to cash without obtaining a loan or selling major parts of the company. A/R factoring is not turning over customers' accounts to a collection company; factoring companies usually accept receivables that are in good standing with the seller. Factoring receivables allows businesses to focus on operations rather than spending time collecting money from past jobs.
Factoring Process
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Factoring companies purchase business receivables at a discount for cash. Factoring purchase amounts are usually from 75 to 90 percent of the total value of the receivables and require that purchased receivables be less than 90 days old. Other requirements may be stipulated, depending on the factoring company and the agreement. Customer creditworthiness, monthly volume and industry will affect the receivables purchase amount and associated fees.
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Disadvantage of Factoring
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The biggest disadvantage to factoring is the fees and discount that the selling company must pay. The seller of the receivables must determine that the fees and discount are less than what he would spend to collect all of the receivables in a timely fashion.
Additionally, it can be difficult to manage customer accounts that have been sold to a factoring agency. Some customers may find this practice misleading and think they have been turned over to a collection agency.
Customer Creditworthiness
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Factoring companies are not collection agencies. They make money by collecting receivables on customers with solid creditworthiness. Additionally, factoring companies will usually not purchase receivables over 90 days old.
When factoring receivables, a seller must prove to the factoring agency that its customer can pay the debt. If a seller cannot, then a recourse factoring agreement may be signed between the seller and factoring agency.
Recourse Factoring
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Recourse factoring allows the factoring agency to hold the seller liable for uncollected receivables. With recourse agreements, the seller pays the fees and discount amount when factoring the receivables and states that he will be liable for any unpaid customer receivables. Continuous unpaid customer receivables may also trigger automatic recourse agreements when using the same factoring agency repeatedly.
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