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The Basics Series: Account Receivable Factoring Basics

What are the Account Receivable Factoring Basics?

Account Receivable Factoring Basics, also commonly referred to as just “factoring”, is a transaction where a business decide to sell or pledge its invoices or accounts receivables.  These accounts are monies owed by its customers and are used as security to a third-party commercial financial company. The factor will then discount the value of the account receivables and give that business residual amount of funds.  This amount will also be off set by the age of those invoices; the older the receivables, the lower the advance.

The main goal of such a transaction is to allow the businesses to release the capital which is related to the account receivables. This can be very useful in case your enterprise needs immediate capital in order to respond to its cash needs, by receiving that capital since it is faster way than waiting the normal receivable period.  Most often, within 24-48 hours the company will receive their advance rather than waiting 30 days or more. The advance amount can be between 80-95%, and then the factor will pay the remaining amount after collecting the payments from the customers and collecting the fees for such a transaction.
Account Receivable Factoring Basics
Account receivable factoring is among one of the oldest form of financing, it’s not the same as a loan and it’s available to all types of companies whether they are big or small companies.

Account Receivable Factoring Basics:  Types of Factoring

We have two types of factoring:

Recourse Factoring: The Company is responsible to buy back the invoices that the customers didn’t pay after a certain period of time.

Non-Recourse Factoring: The factor takes all responsibilities relative to the risks of the non-payments of invoices by your customers.

Account Receivable Factoring Basics:  Pros and cons

The advantages of an account receivable factoring:

  • First of all factory doesn’t have a limit to the amount of financing due to the type of security
  • You can have a faster financing, as a result, less time to wait.
  • It is perfect for small start-up companies in need of immediate financing.
  • You can use your goods for the growth of your business.
  • It doesn’t usually require additional collateral.
  • Most of all, this type of financing isn’t listed as debt on your financial statements.

The disadvantages of an account receivable factoring:

  • It is more expensive than a normal loan.
  • Risks of external frauds by the customers.
  • You might lose control of some of the business processes.
  • Especially relevant, the rate is based on your customers.

In conclusion of Account receivable factoring basics, would be defined as a process allowing businesses to sell their accounts receivables to a factor, which normally consists of a third-party commercial financial company.  The factor will then give to that business an equal amount to a reduced value of the account receivables. It is, most noteworthy, one of the best financing method for most start-up companies in need of immediate capital. The main goal of such a transaction is to allow the businesses to release the capitals which are related to the account receivables. The factor will be then the entity in charge of receiving the payment of your customers, avoiding you the risks related to those transactions, and also in charge of providing you a quick influx of cash in your business.

References:

http://www.investopedia.com/terms/a/accountsreceivablefinancing.asp
https://en.wikipedia.org/wiki/Factoring_(finance)
http://www.businessdictionary.com/definition/factoring.html
https://www.entrepreneur.com/encyclopedia/factoring
http://www.federalnational.com/blog/postid/87/advantages-and-disadvantages-of-factoring.aspx
http://www.nfib.com/content/resources/money/the-advantages-and-disadvantages-of-factoring-51593/

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