One way of accumulating more cash for your working capital, is Accounts Receivable Factoring. Factoring is basically a financial transaction in which a business sells its accounts receivable to a third party (called a factor), at a discount.
Parties involved in the Deal
In this type of financial transactions, three types of parties are generally involved.
-the one who sells the receivable (the business owner)
-the debtor( the account debtor or customer of the seller)
-The factor (often called the third party. )
The two main types of factoring
The common ways of factoring the accounts receivable are as follows:
In advance factoring, the first party (the business owner), sells his receivables in the form of invoice to the Factor (third party), who makes an advance of 70 -85% of the purchase price of the receivable amount. The three major parts to advance factoring are- 1) The Advance, a percentage of the invoice face value which is paid to the seller as an advance. 2) The reserve, the remaining part of the purchase price that is kept in hold until the payment by the account debtor is made. 3) The discount fee, the cost involved in the transaction that is deducted from the reserve, along with other expenses after collection, before the reserve is handed over to the factor’s client.
On the other hand, in maturity factoring, the factor makes no advance payment on the purchased account, but makes sure that the customer pays the full invoiced amount on maturity. But, if the customer does not make payments within the stipulated time, the factor is bound to make the payment to the client on his own and then go to collect the due payment from the customers.
The Role of the factor in factoring
-The factor extends credit to the customers, collects the accounts receivable from the customers and does all the accounting works relating to the book keeping activities.
-The total profit of the factor is the difference between the price paid by him for the invoice and the amount received by him from the debtor less the non-payment amount lost in the deal.
As a whole, today’s rationale of Accounts Receivable Factoring , still involves the financial work of advancing funds to rapidly growing small firms( who again sells to bigger credit worthy firms), without taking possession of their goods or any supportive services, while advancing funds to them.
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