Factoring – Introduction, Functions, Advantages to client & buyer

Factoring is a financial transaction between two parties, client and a factor, in which the client sells its accounts receivable (Money owed to client by a buyer) to the factor to receive money immediately in exchange.

Factoring is an agreement in which receivables arising out of a sale of goods/services are sold by a firm (client) to the factor (financial intermediary) as a result of which the title of  goods/services represented by the receivables passes on to the factor.

It is an arrangement between a factor and his client which includes any two of the following services provided by the factor to the client –

  • Finance
  • Maintenance of account
  • Collection of debts
  • Protection against credit risk

Through factoring an organization (client) relieves itself from the procedures and expenses of collecting receivables arising out of a sale and receives immediate cash to finance its business operations.

 

A factoring agreement involves three parties:

The Factor, The Client (sells receivables to factor), Customer (pays to factor)

Functions of a Factor:

  • Maintaining Accounts – Preparing and updating sales ledger and providing periodic reports with useful information
  • Providing advisory services – Advices the client regarding credit worthiness of a buyer, potential customers, market trends etc.
  • Providing Short-term Finance – Provide money in advance up to 80% of the receivables
  • Providing Credit Protection – Protects the client against bad-debts/non-payment
  • Providing Collection Facilities – Collect money on behalf of the client and remits the money back after deducting his charges

Mechanism of Factoring 

A Factoring contact for sale of receivables –

• It starts with a credit sale and agreement between the client and the buyer/customer.

• The client (seller)

  • Sells goods on credit to buyer/customer
  • Prepares invoice, delivery challan, factoring agreement and other documents
  • Hands over the documents to factor (Financial institution/Banking Institution)
  • Receives payment in advance up to 80% of cost of good by the factor

• The factor

  • Makes an advance payment to factor on receiving all the documents (invoice, challan, agreement etc.)
  • Prepares and sends periodical account statements to customer
  • Receives payment from customer/buyer on due date
  • Remits the balance (20%) from the money collected to the client/seller after deducting its commission, fees, service charges etc.

Advantages of Factoring:

To Client/Seller –

  • The client gets immediate cash on sale which can be invested somewhere else.
  • It protects the client against credit risk i.e. risk of non-payment by buyer.
  • It allows the client to offer lucrative credit schemes to customers and increase his sales and profit.
  • It reduces the financial burden of the client and relieves him maintaining accounts and collection of receivables
  • It acts as an additional source of finance for the client and allows him to explore new markets.

 

To Customers/Buyers – 

  • It allows customers to save bank charges and expenses.
  • It allows customers to purchase expensive products through flexible credit schemes.
  • The factoring procedure is simple and easy than applying for a bank loan, it saves time, money and effort.

 

Also Read: Factoring Process, Types of Factoring, Factoring Importance, Utility and significance

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