A financial arrangement between a client and a factor is known as factoring. The client gets an advance in return for their receivables from the factor which is a financial institution. A unique financial technique, factoring is selling the trade debts by a firm to the third party at a discounted rate.
It is basically an ideal alternative where a client can use their account receivables for financing and there are terms and conditions that both the parties need to abide by. It is a relationship between the factor and the client where the factor will purchase the account receivables of the client and pay about 80% of the sum straightaway. The balance will be paid when the customers clears the outstanding.
What are the different types of factoring?
- Recourse and non recourse factoring: This is a type of an arrangement where the financial institution resorts to a firm in case the debts are not recoverable. Hence, the risk of credit associated with the debt will not be assumed by the factor. On the contrary, non recourse factoring is a form of arrangement where the factor cannot recourse to a firm and the debt turns out to be irrevocable for the client.
- Disclosed and undisclosed factoring: This is a form of factoring where the name of the factor is indicated in the invoice by the supplier of the goods or services, the invoice asks the purchaser to make the payment to the factor and it is known as disclosed factoring. An undisclosed factoring is a form of factoring where the name of the factor is not present on the invoice issued and the factor will maintain the sales ledger and the debt will be realized in the firm’s name.
- Domestic and export factoring: In this case, there are three parties in factoring, one is the customer, one is the client and one is the factor. They all reside in the same country and hence known as domestic factoring. On the other hand, in case of export factoring, there is cross border transaction with four parties including the client, customer, import factor and export factor.
- Advance and maturity factoring: Another type of factoring is advance factoring where a factor will give an advance to the client on the outstanding receivable amount and in case of a maturity factoring, the agency will not provide any advance to the firm. The bank will collect this sum from the customer and will pay the firm when the amount is collected or on the predefined payment date. A fuel advance is an example of advance factoring.
The collection of debt will be performed by the client or the factor based on the type of factoring and the terms and conditions of the agreement. The factor can get control over the debtors of the clients to whom the goods are sold or credit and they also monitor the sales ledger of the client. Factoring plays a crucial role in the financing of a business.