Factoring is a term used in connection with accounts receivable. It refers to a situation where the actual owner of the receivables transfer the ownership to a new entity called factor. Factor acquires all the right of the receivable and collects the payment from the accounts receivable on it own. The factor immediately pays the originator company after deducting certain percentage from the total amount of accounts receivable. By such arrangement, both companies satisfy their objectives. The originator enjoys immediate payment (though after discount deduction) and the factor enjoys profit over the total amount and the amount it pays to the originator company.
| Factoring is also called Accounts Receivable Financing. |
Types of Factoring
There are two types of factoring common in the industry:
1. Non-recourse Factoring
Under this type of factoring, the factor company may keep certain % of the total amount as a security in case of any bad debt. If factor successfully recovers the full amount from receivables, then it returns the security to the originating company. But, in case where the total bad debt exceeds the security amount, then the burden fall over the shoulders of the factor.
2. Recourse Factoring
In order to avoid the burden of excess bad debt over the security amount, factor may enter into a recourse agreement with the originating company. This protects factor from any loss beyond the limit of the security that he has set off initially on account of probable bad debt expense.
Benefits of Factoring
1. It allows you to focus on your business operations rather than running behind the customers to collect payments,
2. It allows easy available of the capital when you need it,
3. It is not a loan, this is your own money. So, you will not be facing issues of highly geared companies,
4. It depends upon the size of your entity, if you are growing, then factoring transaction will also grow.