Businesses need to extend credit to customers in a competitive business environment. Giving credit, however, can strain the finances of smaller companies. By selling their invoices to factoring companies, these small businesses can receive immediate cash to support their operations.
Factoring Companies
There are many factoring companies and a Web search can easily bring up the names of numerous companies. http://www.factors-chain.com/ is a global network of leading factoring companies. Their services can be particularly useful in international trade.
Factoring transactions involve three parties, the seller who makes out the invoice, the factoring company and the buyer of the invoiced goods. On completing the transaction, the factor acquires all the rights that the seller had against the buyer. If the transaction is "no recourse," the factor also bears the risk of the buyer defaulting.
Factors Provide Funds when Banks will not
Small businesses might not be able to get bank loans owing to various reasons. However, if they are selling to larger companies with good credit records, factors will buy the invoices made out to these creditworthy companies. The key element in factoring is the creditworthiness of the buyers and not the sellers.
Factoring is different from invoice discounting. Whereas factoring involves an outright purchase of the receivable, invoice discounting involves giving a loan with the invoice as collateral. Once a factor buys an invoice, they acquire all the rights that go with that invoice, and have to collect the invoice amount directly from the debtor.
Factors typically cannot come back to the seller in case the debtor defaults. On the other hand, the invoice discounter can come back to the seller in case the debtor fails to pay. While this is the typical arrangement, recourse factoring can specifically allow the factor to come back to the seller.
No recourse factoring involves the risk of bad debts, and factoring companies incorporate this risk into the fees they charge sellers. This will be in addition to the interest they charge for the invoice maturity period. The sellers thus get the invoice amount less interest and any fees that factors charge.
Factoring Services Are Expensive
As noted above, factoring can get quite expensive. Sellers will have to consider the margins that they get from their sales. They also have to compare factoring costs against the return they can generate with the immediate cash.
If sales margins are thin, invoice factoring can mean that sellers get an amount less than the cost of making the product they sell. Similarly, if the immediate funds cannot generate a rate of return that is higher than the rate sellers pay for factoring the receivables, it can be a bad tradeoff.
Hence receivables financing is an option that should be evaluated carefully. It is a business decision that involves more than the availability of factoring finance.
Factoring is a financing transaction under which a factoring company pays immediate cash against credit invoices. The seller who makes out the invoices thus need not wait till the end of the credit period to get funds. The factor might even take over the risk associated with bad debts. However, factors cover themselves by charging a fee that covers this risk, and also by buying only those invoices that are drawn on reputed companies.
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