Factoring

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When a business sells its accounts receivables (in the form of invoices) to another business, the process is called factoring.

Why and how it works

Factoring usually includes three parties:

  1. The seller of the product who is waiting for his money and sells the accounts receivable
  2. The debtor who bought the product
  3. The factor (factoring company) who buys the accounts receivable

The factor pays the time value of money (minus a factor's fee) to the seller. Some factoring companies pay a certain percentage (80%-95%) instantly and pay the rest once the debtor pays the factor.

The main incentive for factoring is to get money instantly (instead of often having to wait 30 to 90 days for the payment), thus increasing the present cash flow.

Types of factoring

There are two parameters that can influence the way a factor works: risk and openness.

Risk

The risk of the accounts receivable can transfer to the factor, or it can stay with the seller.

Non recourse factoring refers to the first case - the factor has the risk and cannot turn to the seller if the debtor is unable to pay.

Recourse factoring refers to the case in which the risk stays with the seller.

Openness

Often enough, the debtor does not know of the factor being involved. This is called confidential factoring.

In the case of notified factoring, the factor collects the debts by engaging the debtor directly.

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