Factoring: What is Factoring? Factoring is a progressive financial product, allowing an elegant, straight-forward trade to support business financing. It can further domestic and international trade. It is an effective means of short-term financing and can provide the private sector with easy access to working capital. Most companies' current assets include a high proportion of accounts receivable. Realizing receivables involves costs, including the costs of financing them and of collecting on them. It is essential that receivables be managed properly. Managing receivables involves two types of problems: (1) those related to raising funds/working capital to finance them and (2) those related to collection and the associated delays and defaults. Small companies can manage receivables easily, but large companies can face high costs and bad debts. In such cases, the services of a specialized company, called a factoring company, may be used. Factoring is a powerful financial tool that enables companies to grow successfully, by strengthening their cash flow position. Factoring is a relationship, confirmed by an agreement, between a seller of goods and a financial institution called the factor, where the factor purchases the seller's receivables, which it also controls and administers, while the seller receives cash. Factoring can be a standing relationship between factor and client on an open account basis, with the factor purchasing the client's whole book of debts (all accounts receivable), with or without recourse - relating to control over the customer's credit and administration of the sales ledgers associated with the transaction. The International Institute for the Unification of Private Law, or UNIDROIT, was formed over 25 years ago to promote the international congruity of commercial law. It offers a definition of factoring that includes the following three characteristics: First, there must be provision allowing debts arising from the sale of goods or services under a commercial contract to be assigned. Factoring is not usually associated with consumer debts. Second, there must be provision that debtors be notified of such assignment. Third, the factor must perform at least two of the following services: (1) Provide finance - the factor provides the client with financing, including loans and advance payments (app. 80% of the assigned debts in advance, the balance on the due date after collection). (2) Maintain the accounts receivable - the factor is responsible for administering and maintaining sales ledgers for each client. The factor produces and sends the client periodical reports on the current status of receivables and the amount received from customers. (3) Collect debts - the factor collects the client's receivables, taking over all the problems associated with collection. The client can concentrate on the business, while the cost of collection is reduced through savings in labour, time and effort. (4) Protect against credit risk [e1] - the factor protects the client against the risk of default on payments by customers, but only with non-recourse factoring. Limits up to which the client can sell goods to approved customers are set by the factor. The factor also provides advice on the creditworthiness of potential customers. As the practice of factoring has been worked out in developed countries, a certain consensus has developed over its definition. Factoring [e2] is a financial service that includes the conversion of credit bills (accounts receivable, bills recoverable, and other dues resulting from sales on credit) into cash. The risk associated with the credit can, but does not have to be taken over by the factor purchasing the credit receivables and collecting them when due. The factor makes an advance payment to the client, up to a certain percent of the eligible debts. The client pays a 'commission' [e3] to the factor, as part of the ‘purchase price,' which covers the service aspects of the arrangement, including ledger management, debt collection, credit cover, etc. [e1] http://en.wikipedia.org/wiki/Credit_risk [e2] http://en.wikipedia.org/wiki/Factoring_(finance) [e3] http://en.wikipedia.org/wiki/Commission_(remuneration)
