The idea of spot factoring has its origin in financial transactions. Also known as ‘debtor finance,’ a company trades the invoices to a factor or third party at a discounted price. Businesses consult factors for the receivable assets to fulfill the sudden cash demands.
A factor is an intermediary agent who offers financing to the firms by purchasing the account receivables. The process of factoring is also known as accounts receiving financing or factoring finance.
The practice permits a company to receive capital based on the future income charged from an amount due on a receivable account or business invoice. The receivable accounts embody money that the clients owe to the firm for exchanges on credit.
Types of Factoring
Two types of spot factoring are there. Following are the details
- Resource factoring
Here, the clients need to reimburse unpaid receivable bills from the factors.
- Non-resourcing factoring
Assimilating the unpaid invoices is not comprised here
- Domestic factoring
In this category, the buyer, the client, and the factor belong to the same country.
Functions of Factoring
All the factoring businesses execute several functions as the finance for the supplier, including loans and advance payment. Sometimes they require to maintain a sales ledger. They give immunity against fee default by debtors.
Spot factoring is important as it assists businesses in improving their short-term cash requirements. For accounting purposes, the receivables are reported as current assets on the balance sheets.
What Is The Need for Factoring?
Businesses often undergo cash flow shortfalls when their short-term debts or account bills surpass sales revenue. In these cases, the firms can sell the receivables to a financial provider or a factor to collect cash.
The factor retains a proportion of the receivable with him. The sum may vary as per the creditworthiness. When a business trades the receivables, it transports the default risk to the factor. Factors may claim fees as reimbursement.
Example of Factoring in Finance
Factoring is one of the best strategies of action for a company. By utilizing the factoring method, a company can evolve in no time.
Let a business named ‘Z’ deal with three significant customers, namely A, B, and C. Z, rations products regularly to these three companies. But, often, they disburse after a month of the shipment. The procedure is adversely impacting Z’s growth, so it cannot pay wages to the employees.
Now, the firm decides to trade the invoices or receivables to a factor. They give the invoice copy to the factor called ‘F.’ After clearance, F reimburses 80% of the receivables to Z. Then, F starts to work as the account receivable department and starts servicing the accounts themselves. It delivers the remainder to Z and eliminates the fees when the client pays 100%. It removes worries about payroll.
The unpaid invoices generate a deterrent to business growth. Factoring provides a solution for this problem quickly.