Factoring and discounting, otherwise known as receivables finance, where small businesses sell their invoices upfront at a discount, is the most popular of all the quick cash alternatives out there.
Business factoring is not considered a loan. It is the purchase of a financial asset i.e. a receivable, a financial transaction whereby a business sells its accounts receivables, often their invoices at a discount. Factoring is the sale of receivables differing from invoice discounting-which is considered borrowing, and the receivable is used as collateral.
Business factoring differs from a bank loan because the emphasis is on the value of the receivables- the financial asset, not the firm’s credit worthiness. Also a bank loan involves two parties whereas factoring involves three. The three people are: The Seller of the receivables, the Debtor and the Factor. The factor usually charges the seller a service charge, as well as interest based on how long the factor must wait to receive payments from the debtor.
Different Types of Factoring
Accounts receivable factoring Invoice factoring Domestic factoring Trade factoring Purchase order factoring
Factoring refers to a practice whereby you sell your receivables for a discount before they are due. Today, entrepreneurial companies offering factoring options are willing to buy creditworthy receivables from a variety of resources. Factoring isn’t cheap, you are paying for the cost of the capital, the extra risk including bad debt, and the paperwork factoring requires. But often times for businesses looking for cash, it’s becoming more of an attractive option.
Small businesses are seeking alternative routes to funding for the first time, and entrepreneurs are ready to offer them.