The Role of Factoring in Modern Business Finance
Factoring is an immensely popular concept in modern-day business. It involves one company selling all its invoices or accounts receivable to a third-party vendor company at discounted rates. This way, the first company gets money before the due date(s). With this money, the company is able to fund its operations and production. Work progresses in a timely fashion. The third-party vendor company is referred to as a factoring company. This company pays the first company a rate lesser than what the invoices are actually worth and hence makes a profit.
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Transferring Invoices
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The first company transfers its accounts receivables to the factoring company. The factoring company, on the due dates, presents the invoices and cashes them. The work of the factoring company is very similar to that of credit collection agencies. For these services, the factoring company charges a commission from the first company. For example, a company may approach a factoring company with invoices worth $50,000, and may be paid $49,000. The $1,000 is the commission charged by factoring company.
Value of Invoices
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The creditworthiness of the first company has no role in the factoring process. The third-party company is willing to undertake the contract based on the value of the invoices with the company. There is no question of whether or not the first company would be able to pay for the services utilized. The factoring company evaluates the worth of the accounts receivable and purchases all of them. In the factoring process, the first company sells all its account receivables to one individual factoring firm.
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Ownership of Invoices
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There are three parties involved in the factoring process: a company that owns accounts receivable, its debtors and the factoring company. The first company sells its accounts receivable to the factoring company. Once the factoring company purchases the accounts receivable, it becomes their owner. It has all rights and claims on the invoices. The factoring company approaches the debtors of the first company for payments. In case the debtors do not pay, the factoring company has to suffer the loss.
Tenure of Invoices
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Factoring is done on accounts receivable that are due within 90 to 150 days. It is not used on invoices that are due in less than 90 days or that are due after five months. Factoring is usually attractive to new and emerging companies. These companies often find it difficult to procure loans from the market. They need money to commence their operations. Hence, they fund their processes through collecting money for the sales orders they have received.
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