Factoring, which previously had a stigma and was seen as a last resort for a’ business, has now been gaining popularity. It is becoming the most attractive alternative to commercial loans.
Both the perception and practice of commercial factoring has significantly changed over the years. Individuals who still continue to dismiss factoring can be seen doing so due to a lack of knowledge regarding it. Read on to find out all you need to know about this practice.
What Is Factoring?
Factoring is a financial transaction that involves a business selling its accounts receivables to a third party (the factor) at a discount. The factoring company then later collects the money from the business’s customers to make a profit. At times businesses also factor their receivable assets in order to meet immediate cash requirements. The company providing the funding would charge various fees for its services but helps to provide the business with the required fund without creating any liabilities.
Factoring Helps Reduce Risk
Factoring company helps to hedge risks since they take up most of it upon themselves. For Example if the business is to receive $60,000 from an order, the factor would provide the business with 45,000 (75% of the total amount). If the customer given the order goes bankrupt, the factor would lose money. The business does not then receive the remaining 25% less. The damage would is then less than if the entire amount was lost.
Factoring Can Be Quite Costly
If a business is hiring a factor to manage all its account receivables (invoicing), this could cost the business 4-6 percent of its income. This is why the practice is a better option for larger businesses as compared to smaller ones.
With the changes in practices over the years, selling receivables is now becoming an extremely attractive as well as a better option as compared to commercial loans.