In many lines of business factoring
companies are being used to convert accounts receivable into cash.
Factoring is not the same as assigning accounts receivable as
security for a loan, although most factoring companies handle
both type of financing. In factoring, you enter into an agreement
under which the factor buys all your accounts receivable as they
arise. The accounts sold are no longer among your assets, nor
does the amount received by you from the factor increase your
liabilities since it will not have to be repaid If you borrow
on your accounts receivable, on the other hand, the accounts will
remain as assets and the amount of the loan becomes a liability.
With a loan on receivables, you
are still responsible for collection. However, when you sell the
accounts the factor takes over that function. He assumes all risk
and has no recourse if an account proves uncollectible. For this
reason, the factor will want to pass on the credit standing of
your customers. If he does not approve an account you may still
make the sale, but at your own risk. The factor will not buy that
account.
A factor typically assesses a service
charge of one or two per ecnt on the fact amount of the accounts
purchased. In addition, he will charge interest at an agreed upon
rate for the period between time you receive funds from him and
the average maturity date of the receivables he purchases from
you. Factoring is an expensive method of raising funds, but it
does away with the need for a credit and collection department.
Also, it is often the quickest way for a small business to obtain
cash.
