FACTORING: A way of financing

Factoring

Factoring is a financial term where a businessman sells its accounts receivable (sales bill) to a third party who is called a factor at a discount rate in exchange for immediate money with which to finance further.

 Factoring is a method used by a firm to obtain Cash when the available Cash Balance held by the firm is insufficient to meet current obligations and its other cash needs.

There are three parties who are directly involved are:

·         the one who sells the receivable

·          the debtor

·         the factor

The receivable is like an asset which will be paid by debtor to the seller at an agreed time interval. But during the interval if seller needs urgent money or needs to finance further then he can discount it with factor and obtain cash. The sale of the receivables transfers ownership of the receivables to the factor, thus the factor obtains all of the rights and risks associated with the receivables. And the factor obtains the right to receive the payments made by the debtor at the invoice amount.

There are again two types of factoring:

·         In first type risk is also transferred to the factor. It that case if concerned debtor do not pay then factor will bear the loss. Here percentage of commission of factor is high. Thus seller transfers the risk to the factor. Factor makes full payment at the time of factoring.

·         Is second case risk is not transferred. If debtor do not pay then loss will be borne by the seller. Here seller only gets immediate cash. Factor does not make full payment at the time of factoring, instead he reserve some percentage with himself, in case debtor does not pay. Rate of commission is comparatively less.

Sometimes the factor charges the seller a service charge, as well as interest based on how long the factor must wait to receive payments from the debtor.


 

 

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Comments 2 comments

JYOTI KOTHARI profile image

JYOTI KOTHARI 6 years ago from Jaipur

Hi Garima,

You have explained a technical term of financing in easy way. Thanks for sharing. Thumbs up!

Jyoti Kothari


soumyasrajan 6 years ago from Mumbai India and often in USA

Nice hub Garima! I liked the way you started with a clear cut definitions and then followed with explanations.

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