Brief note on “Meaning of Factoring -a source of Working Capital Finance"
The selling off a company’s accounts receivables i.e. debtors or book debts, at a discount to a factor, which then assumes the credit risk of the debtors and receives cash as the debtors settle their account. Factoring arises when there is working capital gap but bank is not financing the entire gap. Here factors finance the balance part.
In factoring an Escrow account or a designated account requires to open where all the payments comes directly from debtors. It’s a type of collection account.
The factor recover the payment financed from the said account where payments comes directly from debtors on due date.
Some factors may ask for confirmation from the buyer that goods have being received and there is no rejection. But it sometime is practically not workable where payments are released by buyer immediately on delivery of raw materials.
Ex. Suppose the company sends the goods (via road) from some city of North India to lower part of South India which we assume would takes 15 days to reach the materials. Now the customer will check the materials and confirm the same. Suppose if in the entire process 20 days has gone, the benefit of factoring will not reap by the borrower. Now the customer will make the payment immediately hence factoring will not workable in this case.
However, suppose in the above example, the suppliers has to extend a credit of say 60 days. In this case on confirmation by the buyer, supplier will go to the factor and get the bills discounted as there payment would be made with time lag.
In factoring two concepts exists with recourse and without recourse.
-If the party (borrower) gives the guarantee to the factor for payment from buyer, it is called with recourse i.e. the factor does not take on the risk of bad debts.
- If the party (borrower) does not give the guarantee to the factor for payment from buyer, it is called without recourse i.e. the factor takes on the bad debt risk.
Non-recourse factoring will be more expensive than recourse factoring being higher risk involved.
Reverse factoring is also possible. In this case discounting of suppliers' bills is done by factor in respect of the client's (borrower) regular purchases from them.
Source:- Money Point
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