Credit sale of goods and services gives birth to the term factoring. Factoring can be defined as a method in which the debtor (trade debt) is sold to a factoring company at a discount on a continuing basis. In other words, we can say factoring is a process in which a firm (namely the client) receives the short-term finance whenever required from financial institutions (namely the factor) to manage their short term needs in a better position. Traditionally, this kind of service was very common in western countries but now, it is available all over the world. Initially when factoring service came into existence then it was only bank, the only financial institution which act as a factor and helps in collecting its client debt. But, in today’s scenario the picture of a factor has been changed. In today’s date it is considered as much broader concept. Today, any financial institution can act as a factor, he can administer the sales ledger of the client, provide credit control, help in collection of debt, purchases the client’s trade debt including accounts receivable either with or without recourse insurance against non-payment of debts. Thus, we can say that factoring is a combination of providing finance and management services to its client (firm). To put it simple, factor provides its management skills and finance to the firm for a certain fee or commission that varies with interest rates in force in the money market. Factoring is a special activity in which the firm can convert its credit sale of goods and services into cash by selling them to a factoring organization. Factoring service is termed as boom to manufacturer to a dealer of goods and services. With the help of factoring service, the firm can concentrate on the manufacturing goods, expansion of business, serving more customers etc and need not concern itself with non –profitable control and sales accounting matter. Factoring services can be drawn up normally for an initial period of twelve months, continuing thereafter indefinitely until notice (of about six months) is given. Factoring reduces debt worries and improves the cash flow. Factoring is an alternative source of funding which creates no liabilities. Factoring means financial freedom for your business. Factoring is not just about fast cash but it also helps in growth of the business.
The main types of factoring are:
Ø Recourse factoring- In recourse factoring, the factoring company assumes the risk of late payment but the seller retains the credit risk. Upon expiration of the grace period and if a debtor doesn’t pay , the supplier makes payment to the factoring company. The sellers risk is reduced because each customer undergoes a professional verification before hand of its ability to pay. If the factor has given some advance to the supplier then the suppler has to return back the amount received to the factor along with the agreed fees or commission. This type of factoring is also known as pure factoring.
Ø Non recourse factoring-In non-recourse factoring the firm sells the receivables to the factor. The factor makes the payment to the firm immediately or after receiving from the debtor. But in such type of factoring risk is born by the factor. If, the debtor fails to pay the amount of receivable or there is a delay in the payment of receivable then this loss is to be borne by the factor. In other words firm does not have any risk of loss due to delay or default of receivable, all the risk is taken by the factor. Therefore, in order to minimize the risk the factor carefully examines the debtor and his creditworthiness. This type of factoring is also known as full factoring.
Dr. Himani Gupta
Dept. of Management Studies