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.
- What is Receivable / Invoice Factoring?
- Why Receivables / Invoice Factoring?
- Features of Receivables or Invoice Factoring
- Benefits of Receivables or Invoice Factoring
- Factoring vs. Discounting
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.
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
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