Factoring is used by companies for working capital management. A business can sell receivable assets, such as invoices, to a factoring company. The busiest receives cash (and therefore liquidity) and the factor receives a discount the nominal amount of the receivable asset. A business will sometimes factor its receivable assets to meet its present and immediate cash needs.
How Does Invoice Factoring Work?
Factoring is a type of financing that helps improve the cash flow of companies that have slow-paying invoices. Usually, a factoring company purchases the accounts receivable of the client. This purchase gives the client access to immediate funds which can be used to pay for business expenses.
Is factoring short term or long term?
By having a factoring company finance your invoices, the factoring company is effectively leveraging its ability to borrow capital when the invoice selling company cannot. Factoring can be used both as a long and short term solution, although the feasibility of factoring as a long term financing is questionable.
For companies whose working capital needs are highly volatile, factoring can be a feasible solution for working capital management.
In conventional factoring, a supplier finances its receivables. Reverse factoring, however, is a financing solution initiated by the ordering party in order to help its suppliers to finance its receivables more easily and at a lower interest rate than is alternatively available to the supplier.
Recourse vs Non-Recourse
In Non-Recourse factoring, a company sells their accounts receivable to a factor, whom then supplies the cash needed to cover the invoices. The difference with non-recourse factoring is that the factor absorbs all the risk. The company has no liability on uncollected invoices.
Forfaiting is a form of trade and supply chain financing. It involves the purchase of future payment obligations without recourse. Forfaiting can be applied to a wide range of trade-related and even purely financial receivables and payment instruments.