Define Debt Factoring

Selling items on credit

Debt factoring is a method of making sure that a company receives payment for the goods and services it sells. The idea behind factoring is that a company has a contract which gives it the right to collect payments on a loan from a customer. A factor (a third-party company uninvolved in the original contract) purchases this contract from the first company, in exchange for an up-front payment.

Advance Payment

The factor agreement is between the factor and the seller. The factor may be a bank or another financial institution, or it may be another company that wishes to get a return on its cash reserves. The factor advances the seller a percentage of the loan balance. This percentage is usually around 80 percent. The seller receives this portion of the loan balance immediately or within a few days. The factor usually doesn't charge 20 percent; it will charge about 2 percent, paying the seller the remaining balance when it receives payment from the customer.

Risk Reduction

Factor agreements reduce a company's risk. A company that sells most of its products under contracts that require payment over time is taking the risk that its customers will not pay off the loans. The factor will want to see the seller's records so it can estimate the likelihood of a customer not paying off a debt, and if this rate is high, the factor will pay a lower percentage of the loan balance up front.

Factor Debt Collection

The factor receives the debt contract. The customer must now make payments to the factor based on the original contract terms. The factor can make collection calls, send out collection agents and legally enforce penalties for violating the debt contract. Under a recourse factoring agreement, the factor can require the company it has a contract with to return the invoice advance.

Outsourcing Accounts Receivable

Some companies prefer to use a factor since it reduces the amount of staff they need to hire for accounts receivable. A factor is a method of outsourcing, since companies will wish to focus on their main business operations, which may not include debt collection. A factor is not necessarily cheaper than hiring debt collection staff. Factors are professional debt collection companies so they may annoy a company's customers and reduce goodwill. Some factors specialize in a specific type of company. Riviera Finance specializes in factoring for temporary employment agencies.

Factor Requirements

Factors check the financial statements of the company they contract with, although this is a less intensive process than a bank requires for a loan. A company will need to have a high credit score and have been in business for several years before a factor will sign an agreement with them. BRT Financial, for example, requires its partner companies to hold a minimum bank balance and agree to a factoring contract for several months.

References

• Business Link: Debt Factoring
• BRT Financial:
• Riviera Finance: Payroll Funding