Factoring – Introduction, Advantages
and Disadvantages
Factoring is a service of financial nature
involving the conversion of credit bills into cash. Accounts receivables, bills
recoverable and other credit dues resulting from credit sales appear, in the
books of accounts as book credits. Here the risk of credit, risk of credit
worthiness of the debtor and as number of incidental and consequential risks
are involved. These risks are taken by the factor which purchase these credit
receivables without recourse and collects them when due. These balance-sheet
items are replaced by cash received from the factoring agent. Factoring is also
called “Invoice Agent” or purchase and discount of all “receivables”.
Advantages
of Factoring: Factoring provides various benefits to the clients, banks and
customers. We shall discuss the benefits of factoring hereunder:
A. Benefits to the Clients
The
following are the advantages of factoring service to the clients:
1.
The client or seller can convert accounts receivables into cash without
bothering about sales ledger administration even repayment in some cases.
2.
Factoring ensures a definite pattern of cash inflows.
3.
Continuous Factoring virtually eliminates the need for the credit department.
That is why receivable financing through Factoring is gaining popularity as
useful source of financing short term fund requirements of business enterprises
because of the inherent advantage of flexibility it affords to the borrowing
firm. The
seller firm may continue to get finance on its receivables on a more or less
automatic basis. If its sales expand or contract, it can vary the financing
proportionately.
4.
Unlike an unsecured loan, compensating balances are not required in this case.
Another advantage consists of relieving the borrowing firm of substantial
credit and collection costs and further to certain extent from a considerable
part of cash management.
5.
In export sales, difficulties of credit assessment and debt collection are more
pronounced. Availing of Professional factoring services is more advantageous.
6.
Under factoring arrangement, regular cash inflow at periodical intervals is assured.
This helps, short term fund flow and availing of discounts from suppliers.
7.
Firms engaged in a highly seasonal business may submit the peak loan of receivables
to the Factor for credit review and approval as a cheaper alternative to
expanding its own credit department.
8.
Finally, when credit is necessary and cannot be obtained elsewhere either because
of tight money conditions or poor financial position, the Factoring of receivables
will be more appropriate.
B.
Benefits to the Customers
The
following are the advantages of Factoring service to the customers:
1.
The customer is relieved of maintaining record relating to credit sales
customers a/c, reminders to debtors, initiating recovery measures, etc. This
saves substantial administration expenditure.
2.
Factoring as a professional approach in collection of debts inculcates
discipline in cash management among customers.
3.
Buyers have no need to accept any bill.
4.
Buyers will have adequate credit period for payment.
5.
Factoring will facilitate credit purchases.
6.
Saving on bank charges and expenses.
7.
No documentation problems; only a simple undertaking agreeing to make payment
directly to factor is required.
8.
Factor furnishes periodical statement of outstanding invoices drawn on the
buyers.
C.
Benefits to the Banks
The
following are the advantages of Factoring service to the banks:
1.
Factoring provides the banks an integrated receivables management.
2.
Factoring improves the service efficiency of the banks through closer follow up
of credit sales.
3.
Factoring provides increasing cash flow and liquidity to the banks.
4.
Factoring improves the quality of the advances made by the banks by reducing
the turnover of receivables and by increasing operating cycles.
5.
Factoring enhances the profits through cash discounts on purchase.
6.
Factoring safeguards as insurance against non-performing assets of the banks.
In this, all proceeds of factored bills are credited to bank; hence bank
account will not become non-performing assets for shortage of credits.
Factoring
service suffers from the following limitations:
1.
Factoring is a high risk prone area: It may
possibly result in over dependence on Factoring, mismanagement, over trading or
even dishonesty on the client's part.
2.
Factoring as a costly source of financing: The
cost of financing being higher than the normal lending rate, Factoring is an
expensive way of financing.