Factoring is a business funding type whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount.
In “advance” factoring, the factor provides financing to the seller of the accounts in the form of a cash “advance,” often 70-85% of the purchase price of the accounts, with the balance of the purchase price being paid, net of the factor’s discount fee (commission) and other charges, upon collection from the account client. In “maturity” factoring, the factor makes no advance on the purchased accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being purchased in the batch.
Today factoring’s rationale still includes the financial task of advancing funds to smaller rapidly growing firms who sell to larger more creditworthy organizations. While almost never taking possession of the goods sold, factors offer various combinations of money and supportive services when advancing funds.
Factoring is a method used by some firms to obtain venture capital. Certain companies factor accounts when the available cash balance held by the firm is insufficient to meet current obligations and accommodate its other cash needs, such as new orders or contracts; in other industries, however, such as textiles or apparel, for example, financially sound companies factor their accounts simply because this is the historic method of business funding.
The use of factoring to obtain the cash needed to accommodate a firm’s immediate cash flow needs will allow the firm to maintain a smaller ongoing cash balance. By reducing the size of its cash balances, more money is made available for investment in the firm’s growth.
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