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HomeBUSINESSWhat is Factoring and how does this financing system work?

What is Factoring and how does this financing system work?

Do you know what factoring consists of and what it is for? In this article we will explain what it is and how companies use it.

To begin with, it can be said that the factoring It is a financial operation through which a company assigns or sells its accounts receivable or invoices at a discount to a third party, which is generally a financial institution or a specialized factoring firm, with the aim of obtaining immediate liquidity.

Through a contract factoringa company transfers the future collection of its accounts receivable, obtaining the money immediately, in exchange for a discount.

Factoring as a financing system

Suppose that a company made a sale for 1,000 dollars and issued another company that bought it, an invoice for this amount to be collected in 30 days.

The company issuing the invoice has the option of selling this account receivable to a bank or factoring.

This will be purchased at a discount rate of, say, 3%, giving you $970.

The bank will be in charge of collecting that invoice and will receive the full amount, that is, the 1,000 dollars.

The bank or company factoring assumes the risk of insolvency of the account receivable in exchange for a commission, or factoring that is based on the due date of the invoice, the amount of invoices negotiated, the quality of the debtors and more.

Companies may face cash shortfalls if a large portion of their sales are in accounts receivable. It is at this moment when the factoring It is a financing alternative.

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How the factoring mechanism works in companies

In an operation of factoring Three main actors are involved:

  • The client, which is the company that sells or transfers the account receivable and which requires liquidity.
  • The factor, which is the bank or institution that provides factoring and that you will buy the accounts receivable in exchange for a discount rate y.
  • The debtor of the invoice or account receivable that is sold.

The process of factoring develops as follows:

  1. The client has in his possession an invoice that he has issued to the debtor for a certain amount.
  2. The client requires liquidity and decides to go to a company factoringwhich will request a series of requirements, including a credit analysis of the debtor.
  3. Once the contract is signed factoringthe client must send the invoice to the company of factoringwhich will advance the client a percentage of the invoice amount, generally 80%, but it will depend on the amount of the transaction, the economic sector and other risk parameters.
  4. the company of factoring shall collect from the debtor in accordance with the terms of the invoice.
  5. Once the complete invoice has been collected, the company factoring will send the client the remaining amount less the previously agreed discount percentage.

Advantages and disadvantages of financing through factoring

What is factoring for companies?

Companies that decide to use this type of financing can obtain great advantages when compared to other financial instruments, but the risks and disadvantages they will face must also be considered.

Advantages

1. Improve cash flow. Invoice collections are immediate, having the resources available long before the due date of the invoice and avoiding collection expenses.

2. Invoice factoring helps to keep the company healthysince the cash flow deficit is one of the main factors of business failure.

3. Avoid collection costs and the use of personnel dedicated to these tasks.

4. Invoice factoring is usually faster and cheaper than a bank loan, which makes it a suitable procedure for short-term financing needs

Disadvantages

1. Not a good fit for companies with few customers because the companies factoring They prefer to spread the risk.

2. Often contracts for factoring could signify a medium-term commitment with the company of factoring, so the customer will not be able to stop deducting invoices at any time they want. It is an important business decision.

3. It is not a good option for companies whose clients are high risk, since they will have to pay high discount rates.

4. When accounts receivable are sold, in part you are handing over control of your relationships with your customers.

Study this financial alternative

Factoring has become an attractive option for many businesses, as it allows them to get a cash advance without having to wait for their customers to pay their invoices.

This is particularly beneficial for businesses that have limited cash flow or are growing rapidly and need additional financing to meet expenses.

Additionally, factoring is a flexible option as companies can sell all or some of their outstanding invoices, allowing them to tailor financing to their needs.

It can also be a useful alternative for businesses that have difficulty obtaining bank loans due to their credit history or short time on the market.

In short, factoring is a powerful financial tool that can help companies maintain healthy cash flow and finance their growth effectively.

If you are looking for a reliable and flexible source of financing for your business, consider factoring as a viable option.

Continue reading: 10 effective strategies to increase the sales of your business

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