Factoring is simply selling your invoices to a factoring company, the company buys them from you face value, less their fees. You get the cash quickly and don't have to collect the debt. The trade-off is that you lose a percentage of the value of the invoice, as the factoring company acquires the debt and collects it, and makes a profit by paying you less than the value of the invoice. This fee may work out to be comparable to an ordinary bank loan, so from a financial of view there is no disadvantage here.
The process starts when you sell your service or product to a customer and raise and invoice. To factor the invoice, you send a copy of the invoice to the factoring company, and the factor then sends you a percentage of the invoice amount, called the advance. The is the first of two payments you receive when factoring am invoice.
The next step the process is when the customer pays the invoice. The factor then sends you the second payment, called he reserve, after withholding the factoring fee. You don't collect the payment, but the factor can either do this on your behalf so that the client doesn't know you're using an external, or on own behalf.
If the client does not pay the invoice, normally, the factor does not take on the risk of a bad debt and will be able to reclaim the money from you if the client does not pay the invoice. This is known as recourse factoring.
The alternative is non-recourse factoring, whereby the factor take on the bad debt risk. it is more expensive but means that you never to repay the advance to the factor. You factor will pursues the customer for the debt and take any necessary legal action.
Factoring is a highly flexible service that lets you retain full control over your sales ledger, or hand it over to the finance company. The choice is yours.
