Factoring is defined as a financing technique which involves a financial agreement between 2 parties, namely, factor & a client in which the firm (client) gets advances in return for receivables, from a financial institution (factor).
A factor is essentially a funding source that agrees to pay a company the value of an invoice less a discount for commission and fees.
It is also known as accounts receivable factoring or invoice factoring.
Companies choose factoring if they want to receive cash quickly rather than waiting for the duration of the credit terms. It helps the companies to fulfill their financial obligations by providing immediate funds.
PROCESS OF FACTORING
Factoring, basically involves an agreement between the factor & the company in which the factor agrees to purchase the client’s Account Receivables & pay upto 80 – 85% of the invoice value immediately.
The company gets the balance amount (including finance cost & operating cost) when the customer has paid the invoice to the factoring company.
The Factoring company also charges “factoring fee” which is a percentage of the amount of receivables factored.
TYPES OF FACTORING
The various types of factoring are classified below :
RECOURSE FACTORING – In this type of arrangement, the financial institution, can resort to the firm, when the debts are not recoverable. So, the credit risk associated with the trade debts are not assumed by the factor.
NON – RECOURSE FACTORING – In this type, the factor has to bear the loss arising on account of irrecoverable receivables . He can only charge high commissions as compensation but not claim any refund.
DISCLOSED FACTORING – In disclosed factoring, the name of the factor is disclosed in the invoice by the supplier of the goods asking the buyer to make payment to the factor.
UNDISCLOSED FACTORING – The form of factoring in which the name of the factor is not mentioned in the invoice issued by the manufacturer is called undisclosed factoring.
DOMESTIC FACTORING – In this type, the parties involved in the arrangement i.e the factor, client & the customer are from the same country.
EXPORT FACTORING – In this type of factoring, the parties involved i.e. exporter (client) , the importer (customer) , export factor & import factor reside in different countries. It is also known as cross border or international factoring.
ADVANCE FACTORING – In advance factoring, the factor gives an advance to the client, against the uncollected receivables.
MATURITY FACTORING – In maturity factoring , the factor does not make any advance payment to the client. The payment is made either on the date of collection or on a guaranteed maturity date.
Thus, the collection of debt is done by the factor or the client depending upon the type of Factoring arrangement.