Receivables / Invoice Factoring

What is Receivable / Invoice Factoring?

Receivable / Invoice factoring is a financial service whereby the account receivables of the business are sold to the factor (one who provides factoring services), and cash is realized well in advance. The responsibility of realization from the customer lies with the factor and also the credit risk associated with it. A commission/fee is charged as per the agreement between factor and business.

Why Receivables / Invoice Factoring?

Achieving milestones and milestones in sales is not sufficient to generate cash profits; they are generated only after the sales are realized in cash. In a business, converting sales into cash is a more difficult task than making sales itself. Factoring is the ultimate solution to this difficulty.

Features of Receivables or Invoice Factoring

Collection from Customers

The responsibility of realization from the customer lies with the factor. The credit risk associated with it may or may not fall with the factor. It depends on the factoring agreement whether it mentions with or without recourse factoring.

Receivable/ Invoice Factoring

Factoring Fee

A commission/fee is charged as per the agreement between factor and business. It is normally charged in percentage terms.

A Source of Short-Term Finance

From a different perspective, accounts receivable factoring can be seen as an innovative way of Working Capital Financing. Although cost-wise, the deal may not be very attractive because the factor charges would include the interest on the amount advanced to the business and the service charge for other services. At the same time, comparing factoring costs with other financing options would not be correct because it is not direct financing. It is a bundle of more than one service.

Types of Factoring

A different type of factoring can be defined based on the structural changes in terms of factoring mentioned in an agreement between the business and the factor.

It can be with or without recourse which means the credit risk may or may not be assumed by the factor. Advance or maturity factoring, which means the money may or may not be paid in advance. There can be the only financing of invoices with no other service, but that can become as good as invoice discounting.

Factoring Services apart from Financing

The other services which can be a part of factoring services apart from advancing the invoices are

  • Collection from customers,
  • Credit investigation,
  • Sales ledger management, etc.

Subscribing to such services may be at the seller’s option or the company taking factoring services. Collection from a customer is a common service present in all factoring services. Credit investigation means checking the credit of the customers by the factors in place of the business, which thereby eliminates the need for any credit department in the business enterprise. Sales ledger maintenance is another added service that the factors can provide.

Benefits of Receivables or Invoice Factoring

  • Invoice factoring offers various benefits to a business.
  • Most important of all is the conversion of account receivables/debtors into cash.
  • Secondly, the burden of collection from the customer is also shifted to the factor’s head.
  • Since the cash collection from debtors is not a responsibility of the business, their cash flow pattern becomes simple, and therefore cash flow forecasting and budgeting becomes easier.

Factoring vs. Discounting

You should not confuse factoring with invoice discounting. They are entirely different financial transactions. There is no doubt that in both cases, cash is received based on the account receivables. In factoring, the account receivables are sold to the factor, whereas, in bill discounting, the bank or the financial institute takes account receivables as collateral against the money they are lending. In essence, the bank is not responsible for the credibility of the debtors, whereas, in the case of factors, they take that responsibility usually.

For a clear understanding of the differences between the two, refer to Factoring Vs. Discounting

Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

2 thoughts on “Receivables / Invoice Factoring”

  1. Invoice factoring is definitely a great financing solution. I think that with the help of this, business will definitely grow. A lot of business owners uses this as well. Thanks for sharing this article.

  2. Yes, I totally agree with what you said. I think that factoring has a lot of benefit. I think that business will succeed with the help of factoring financing. Thanks for sharing this article.


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