What is Factoring?
Factoring is a mechanism of managing, financing and collecting receivables.
Credit management is one of the most important activity which needs lots of time and effort of a company. Collection of receivables poses a problem,particularly for small-scale enterprises. However, there are many banks which finances the receivables. However, this support is available for a limited period and the seller of goods and services has to bear the risk of default by debtors.
This concept is quite popular in USA and UK. However, now factoring is also becoming noticeable in India as well.
Nature of Factoring
First of all, it is one of the most innovation finance product till date. It provides both management as well as financial support to the company or clients. In other words, it is a method of converting a non-productive asset into a productive asset as there involves selling of receivables to a company that specializes in their collection and administration.
If companies are not able to turn their accounts receivable into cash for a long time, then ash will become a scarce resource. So it is much better to sell that asset for cash which can be immediately employed in the business. A factor makes the conversion of receivables into cash possible.
The firm sends the customer’s order to the factor for evaluating the creditworthiness of the customers. Once factor is satisfied about the customer and agrees to buy receivables, the firm dispatches the goods to the customers. At the same time, customers are intimated that their account has been sold to the factor. He is also instructed to make the payment directly to the factor. Once the factor has purchased a firm’s receivables and if he agrees to own them, he will have to provide the protection against any bad debt losses to the firm.
The factor provides the following three basic services to clients –
- Sales ledger administration and credit management.
- Credit collection and protection against default and bad debts.
- Financial accommodation against assigned book debts.