Factoring is basically a fund-based facility. In a typical factoring arrangement, the client (you) makes a sale, delivers the product or service and generates an invoice (accounts receivable), and a financial institution / funding source (factor) buys the right to collect on the accounts receivables of the client and pays up to 80% (and on rare cases up to 90%) of the amount immediately on agreement, and the remaining amount i.e. 20% or 10% when the customer pays. The factor also manages sales ledger and also follows up with client’s customers and collects the debts. Usually the period of factoring is 90 to 150 days. Some factoring companies allow even more than 150 days, depending upon the type of agreement or the relation between the factor and the client.
Because factors extend credit not to their clients but to their clients’ customers, they are more concerned about the customers’ ability to pay than the client’s financial status. Factoring is not a loan; it does not create a liability on the balance sheet or encumber assets. It is the sale of an asset.
We shall study about this article further, in detail, in our next post.