Doing any business in the current economic situation cannot be imagined without additional borrowing. Creditors may be banks, credit organizations, and third-party enterprises. A regular loan for a business involves the provision of collateral as collateral. Factoring conditions are different. Let’s deal with this concept in more detail.
Factoring in simple words
This is not to say that this type of transaction has appeared relatively recently. Initially, it was in demand in the West. Then our entrepreneurs began to use such conditions for doing business.
In other words, factoring is the transfer of receivables to a third party in order to stabilize a business project . That is, the company sells any product. Bills the customer for it. According to accounting concepts: an account is deferred income. The buyer does not pay this bill immediately. Accordingly, the company does not have this money yet. The factoring company or the bank undertakes to pay this bill earlier than the buyer does. The amount of payment may not exceed 90% of the amount indicated in the invoice. As a result of such a financial transaction, an intermediary appears between the seller and the buyer.
Consider factoring as an example.
The company sells building materials. She delivers them to a chain of construction stores. These stores pay for the goods provided with a delay of two months (by agreement). Because of this, the company cannot double its financial turnover. Therefore, he cannot get a loan or reach a new level of development.
While the chain of construction stores will pay for the goods, the supplier company needs to pay for the rental of a warehouse, office and so on. Working capital for such needs is not enough. In accounting, this situation is called the cash gap. And to reduce it, you can use factoring.
An organization that agrees to assume obligations to pay receivables will immediately transfer the construction company payment TD Bank Routing Number of the invoice in the amount of 80-90%. After the buyer settles with the supplier, the factoring organization will deduct from the sum of receipts not only paid 80-90%, but also the commission for their services.
Parties to factoring
There are three of them:
- Creditor – a seller who sells goods on a deferred payment basis;
- Debtor – a buyer paying for goods with a certain delay;
- Factor – an intermediary, which can be a factoring organization or a bank.
The last party buys short-term receivables, while providing cash to the seller.
How factoring works
Initially, you need to clarify that the company sells goods with deferred payment. These terms of the transaction must be specified in the contract between it and the buyer.
- A company with this contract and an invoice for the payment of goods (services) refers to the factor. Concludes a factoring agreement with him. Then the parties agree on how the document flow will occur. From the moment of signing the contract with the factoring company, accounts receivable already belong to her. The buyer pays the invoice for payment of goods at the requisites of the factor.
- The factor on the basis of the signed agreement transfers the creditor cash in the amount of 70-100% of the amount indicated in the invoice. In practice, this amount does not exceed 90%. Cash is already with the seller of the goods.
- The buyer transfers the money for the goods of the factoring company in full.
As soon as the money for the goods on the factor’s account, he transfers to the seller’s account the amount of payment minus the payment for the goods paid and the commission for the service provided. The size of this commission varies between 0.5-4% of the transaction amount.
Types of factoring
The first variety is factoring with regression (classic). It means that the goods are sold with a delay, and the factor buys from the company about 90% of the receivables. If the buyer does not pay for his obligations, the factor has the right to demand from the seller the return of the money transferred by him. That is, the factoring company minimized the risk of capital loss.
The second variety is factoring without recourse. Such terms of the transaction mean that the intermediary (factoring company) independently requires money from the buyer in case of their untimely or incomplete transfer. In this case, the seller remains aloof.
The third type is reverse factoring. It implies the possibility for the seller (creditor) of deferring payments for the products received or for debts.
Types of factoring by the type of transactions concluded:
- Open – the debtor (buyer) is informed that he must pay the debt on the details of the factoring company.
- Closed – the creditor does not inform the debtor (buyer) that the intermediary is involved in the transaction.
There is also internal factoring. This is when the financial relations of participants occur in the territory of one state. External factoring involves the participation of parties from different countries.
Factoring is a financial service that benefits both the seller (creditor) and the factoring company. The first immediately receives money for the goods for which they had to pay off with a delay. The second is the commission for their services. As for the debtor (buyer), he must timely pay his debt for goods or services (according to the terms of the contract). Otherwise, the factoring company has the right to issue him an additional fee for late payment. But all this depends on what conditions of the factoring transaction were signed by the creditor (seller) and the factor (intermediary).