Factoring has a long and rich tradition, dating back 4,000
years. Almost every civilization that valued commerce has practiced some form
of factoring, including the Romans who were the first to sell actual promissory
notes at a discount. The first widespread, documented use of factoring occurred
in the American colonies before the revolution.
With the advent of the industrial revolution, factoring
became more focused on the issue of credit, although the basic premise remained
same. By assisting clients in determining the creditworthiness of their
customer and setting credit limits, factors could actually guarantee payments
for approved customers. Prior to the 1930s, factoring in this country occurred
primarily in the textile and garment industries, as the industries were direct
descendants of the colonial economy that used factoring so specifically.
As time is passing by, and we are moving into the modern era
of instant communication and a shrinking world, factoring plays an important
role in the todays business. The increasing interest rates that marked the
1980's and 1990 are led to an increase in the number of new companies turning
to the factoring business. Factoring is a way to raise quick capital in a
manner that was called "off the balance sheet" financing. Since
accounts receivables are an asset account, factoring is a way to raise quick
cash without adding the liability of loan.
Introduction
Factoring is one of the oldest forms of business financing.
It can be regarded as a cash management tool for many companies like garment
industry where long receivables are a part of business cycle. Factoring is a
service that covers the financing and collection of account receivables in
domestic and international trade.
It is an ongoing arrangement between the exporter and
factor. The exporter sells invoiced receivables at a discount to the factor to
raise finance for working capital requirement. It bridges the gap between
raising an invoice and getting that invoice paid. By obtaining payment of the
invoices immediately from the factor, usually up to 80 per cent of their value
the companys cash flow is improved. The factor charges service fees that vary
with interest rates in force in the money market. The factor operates by buying
the invoiced debts from the selling company. These are purchased, usually with
credit control, collection and sales accounting work. Thus the management of
the company may concentrate on production and sales and need not concern itself
with non-profitable control and sales accounting matters.
Factoring differs from a bank loan in three main ways.
First, factoring differs from traditional bank loans because the credit
decision is strictly based on receivables rather than other factors like how
long the company has been in business, working capital and personal credit
score. Secondly, factoring is not a loan; it is the purchase of financial
asset. Finally, a bank loan involves two parties whereas factoring involves
three-buyer, exporter and factor.
There is some misconception regarding factoring like people
believe factors are a lender of last resort but that is not true because
exporters seeking out factoring are often in the beginning stages of growth. At
first glance, factoring appears to be expensive but does a lot more; in essence,
factoring replaces the accounts receivables and credit department.
Advantages
- Factoring helps to turn the receivables instantly into
cash
- It provides credit protection for the receivables
- It helps the business to meet increasing sales demand
and expand
- Factoring helps in saving time as the invoice financing
company collects the money itself
Disadvantages
- The basic disadvantage of factoring is that it may lead
to ruined relations with the customers especially if factor engages in
aggressive or unprofessional practices when collecting accounts
- Cost is another disadvantage, cost involved in
factoring agreement may be more than the cost of other methods of
financing available in the business
