Concept of Factoring

Factoring is a method by which a businessman can obtain cash for invoices he sends to
his customers in respect of supply of goods and services to them. Factoring is also
termed as ‘Invoice Discounting.’ Factoring involves the sale of receivables to a financial
institution such as an old line factor—a commercial financial company or one of a few
commercial banks. The factor purchases accounts acceptable to him generally without
recourse; if the customer does not pay, the factor takes the loss. The client no longer
carries factored account receivable on his balance sheet, in effect having converted
them into cash. Firms owing the accounts receivable to client firms are notified that the
account has been sold to the factor and are asked to remit directly to the factor.
It is noteworthy that the factor seldom agrees to buy all of the accounts receivable of a
client firm; instead, he retains the right to screen the accounts and selects those
acceptable to him. The client firm can continue to sell to customers whose accounts
are unacceptable to the factor, but it must carry them itself and assume all risks on
them.
Factoring involves rendering of services varying from the bill discounting facilities offered
by commercial banks to a total takeover of administration of the sales ledger and credit
control functions, from credit approval to collecting cash, credit insurance and provision
of finance. Factoring agreement is normally continuous. As new receivables arise, they are regularly sold to the factor. Under the typical factoring arrangement the client
maintains a running account with the factor.As receivables are sold to the factor, the
proceeds are put at the client’s disposal in this account. Often, clients are given the
privilege of overdrawing their account with the factor, or, in effect, of borrowing on an
unsecured basis, in addition to drawing against the proceeds of the factored accounts.
Also, interest is normally credited by the factor on funds left with him.

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