Factoring finance
Many commercial finance companies do factoring. Those whose primary business is factoring are called factors.
In the standard factoring understanding, the factor buys the clients receivables complete, without choice, as soon as the client creates them by its shipment of goods to customers .Although the factor usually has recourse to the borrower for returns, errors in pricing, etc., the factor assumes the risk of bad debt losses. The factor investigates and approves the credit of customers whose accounts are being factored .As soon as the proof of shipment exists, cash is made by the client . The arrangement is generally flexible in that the client may draw down the full proceeds of the sale or leave the proceeds with the factor until the due date .
Factoring is a form of borrowing against receivables without involving a draft and without showing an offsetting liability on the books in the form of a loan. The cost for this type of borrowing is determined by the risk level that the receivables represent to the factor. The factor establishes this cost after credit research and determination of the need for possible credit insurance . Also affecting the cost is whether the factor purchases the receivables on a recourse or non-recourse basis. In the case of non-recourse purchase, the exporter is not bound to repay the factoring house if the foreign buyer defaults or other collection problems arise, therefore, the fee percentage charged will be greater with a non-recourse purchase .
Although factoring of accounts receivable appears to be similar to a loan, with accounts receivable pledged as collateral, it is really quite different . Factoring is the sale of accounts receivable, usually without recourse, to another party, hereafter called the factor. Once the account has been purchased, it is the property and responsibility of the factor. There are three major types of factoring arrangements. They are maturity factoring, conventional factoring and maturity factory with an assignment of equity.
Factoring, like accounts receivable financing, done by a notification basis or a non-notification basis .When on the notification basis, the factor checks credit, makes collections, and keeps records. Customers are required to remit payment directly to the factor. In non-notification factoring, the factor obtains the receivables entire without choice, but does not assume the collection function.
A hybrid type of factoring is one in which the bank lends a percentage of the value of the accounts receivable to the business and, in turn, takes a security interest in the accounts receivable .This is not true factoring, but more a combination of factoring and accounts receivable financing. Because the risk to the lender is lower, the cost of these hybrid forms of factoring is generally less than that of non-recourse factoring.
Both commercial finance companies and factoring firms will do some inventory financing .Commercial finance companies and factoring firms do a smaller percentage of their financing volume in longer term loans. Because these financings tend to be those that would not usually interest a commercial bank, the rate charged is higher than bank rates on similar loans .
Like banks, commercial finance and factoring companies will make unsecured loans on either a short or an intermediate term basis .Usually the lender expects the unsecured loan to be transformed into a loan secured by collateral in the form of receivables when goods are shipped .
A number of commercial finance companies lease important on the same general terms as specialized leasing companies use.
Commercial finance and factoring firms also provide on a limited basis a number of financing options not offered by commercial banks. Below are brief descriptions of a few of these.
- factor issues a payment guarantee to a supplier of a client, making it possible for the client to purchase raw materials on a discounted basis that would not have been allowed without the guarantee .
- Both commercial finance and factoring firms will, from time to time, advance more cash to their client than the loan limit specified in their agreement . This is done when the lender has developed sufficient confidence in the borrowers ability to repay . In effect, a very short term unsecured loan is provided to the borrower, generally at the same rate as the secured borrowing .
- Many large and financially strong firms do not need financing, but they can benefit from the credit and collection capability of larger commercial finance and factoring firms .
Occasionally a commercial finance or factoring company will participate in a financing arrangement with a bank .This may be initiated by the bank when a client companys need for working capital has grown beyond the bankÃÂs credit limits. Or it may be initiated by the commercial finance company when it would like to spread its risk, or leverage its capital .Usually the finance company and the bank each put up some percentage of the financing . The finance company administers the financing, thereby saving the bank the handling costs of the financing .The bank receives interest on its portion of the loan and requires a compensating balance from the borrower .The finance company is able both to get its going rate and to obtain for its client a lower overall rate .
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