Adopt factoring to overcome cash flow problems

02 Nov '09

6 min read

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 1930's, 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 today's 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.

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 company's 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, abank loan involves two parties whereas factoring involves three – buyer, exporter and factor.

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