2. DEFINITION Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three. It is different from the forfaiting in the sense that forfaiting is a transaction based operation while factoring is a firm based operation - meaning, in factoring, a firm sells all its receivables while in forfaiting, the firm sells one of its transactions.
3. REASON FOR FACTORING Factoring is a method used by a firm to obtain Cash when the available Cash Balance held by the firm is insufficient to meet current obligations and accommodate its other cash needs, such as new orders or contracts. The use of Factoring to obtain the Cash needed to accommodate the firm’s immediate Cash needs will allow the firm to maintain a smaller ongoing Cash Balance. By reducing the size of its Cash Balances, more money is made available for investment in the firm’s growth. A company sells its invoices at a discount to their face value when it calculates that it will be better off using the proceeds to bolster its own growth than it would be by effectively functioning as its "customer's bank." Accordingly, Factoring occurs when the rate of return on the proceeds invested in production exceed the costs associated with Factoring the Receivables. Therefore, the trade off between the return the firm earns on investment in production and the cost of utilizing a Factor is crucial in determining both the extent Factoring is used and the quantity of Cash the firm holds on hand.
4. FUNCTIONS OF THE FACTORING Financing facility Maintenance or Administration of a sales ledger Collection facility of accounts Receivables Advisory service
5. ADVANTAGES This is a off-balance sheet financing process. Reduction of current liabilities. Improvement in current ratio. More time for planning & production. Reduction of cost & expenses.
7. RECOURSE FACTORING This is a type of factoring in which receivables are sold to the factor with the understanding that all credit risk would be the bond by the firm.
8. NON-RECOURSE FACTORING This a type of factoring process in which receivables are sold to the factor with the understanding that all credit risk would be bond by the factors.
9. MATURITY FACTORING In this type of factoring , factor does not make any advance payment to the client. The amount will paid by the factor on the guaranteed payment date or at the time of collection from debtors.
10. INVOICE FACTORING It is simply a bill discounting process. Invoice discounting is a form of short-term borrowing often used to improve a company's working capital and cash flow position. Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid. To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the borrowing.
