Debt Factoring definition
Debt factoring is a form of commercial finance which allows a business to sell its debtors (accounts receivable) to a third party, known as a ‘factor’ in return for an immediate cash advance, often between 70-85% of the invoice amount. On payment by the original debtor to the factor of the full amount, the factor will pay over the rest of the amount less a 2-3% fee. Why use Debt Factoring as a form of financing?
Debt factoring can be a very effective way of a business freeing up cash in its debtors book that it might otherwise have to wait 30 days or more for under standard credit terms. Factoring can either be ‘recourse’ or ‘non-recourse’ in nature. Recourse means that if the factor cannot recover the amount from the original debtor, it will go back to the business it advanced the money to, to recover the amount owed. Non-recourse means that the factor will go after the original debtor to collect any amounts outstanding. Debt Factoring Advantages
Provided that the business’ debtors are credit-worthy, the business can get access to cash very quickly (often the next day) to aid in its cash flow and use in the business. The access to instant cash is usually more valuable than the payment of a 2-3% of the invoice value as a fee. If the business has a well-known factor (e.g. High Street Bank) as its factor, this can add gravitas to its credit control, forcing debtors to pay quicker. Debt Factoring Disadvantages
Debt factoring can be an expensive form of financing for a business and there may be other ways that result in lower cost. There may also be the loss of control of the debtor book once a business uses factoring. If a debtor fails to pay and the factoring is recourse in nature, the factoring company will then pursue the business to reclaim the debt and this will almost certainly result in additional costs being incurred to retrieve the debt. Factoring companies will usually only work with businesses with a stable...
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