Factoring of accounts receivable is a popular way to address working capital needs. It is a simple idea at heart: it extracts value from unpaid invoices by allowing them to be sold to a third party lender, commonly referred to as a factor. This process gives you cash that you need now, bridging the gap between what you currently have and what you need to deliver on the various invoices that you've sent to customers. But despite its many advantages, a/r financing isn't always right for every company. Is it the best option for you?
A Detailed Understanding Of A/R Financing
Factoring functions similarly to a loan, although the technical structure of it is substantially different. In a loan, there is a concept of lending money, which will be paid back in full at a later date. Depending on the structure of the agreement there may be regular installment payments, or it may simply be due in full at a later time. This kind of funding is similar to a loan with repayment due at a certain time - something like an asset-based agreement or a/r lending. But the difference here is that rather than having a lending agreement, there is a purchase agreement. The relevant receivables are sold to the bank or other third party company. They own them, which means that when the client's payment does come through, it goes directly to the third party. This may seem strange, but it's actually a substantial advantage. In many cases, this sale transaction transfers the liability for your client's non-payment to the third party. Unlike in many other lending structures, if your client defaults or otherwise fails to pay up, you may not be liable.
Benefits To Consider
The major benefit of this form of capital is that it is very flexible. Companies can often bend their own rules because of how much control they have over what they ultimately are getting. It's a great choice for companies that are otherwise struggling to obtain their necessary funds.
Exploring Some Drawbacks
The major drawback is that you're going to ultimately get less of the invoice in the long run. You're trading a portion of the long-term face value for an instant infusion upfront. Now that isn't always bad - in fact, it can often be exactly what your company requires - but it's important to remember that when you consider whether to factor a given invoice or not. If your business can sustain without it, it may be more beneficial for you to do so in the longer term even if it means slightly less flexibility in the shorter term.
A Detailed Understanding Of A/R Financing
Factoring functions similarly to a loan, although the technical structure of it is substantially different. In a loan, there is a concept of lending money, which will be paid back in full at a later date. Depending on the structure of the agreement there may be regular installment payments, or it may simply be due in full at a later time. This kind of funding is similar to a loan with repayment due at a certain time - something like an asset-based agreement or a/r lending. But the difference here is that rather than having a lending agreement, there is a purchase agreement. The relevant receivables are sold to the bank or other third party company. They own them, which means that when the client's payment does come through, it goes directly to the third party. This may seem strange, but it's actually a substantial advantage. In many cases, this sale transaction transfers the liability for your client's non-payment to the third party. Unlike in many other lending structures, if your client defaults or otherwise fails to pay up, you may not be liable.
Benefits To Consider
The major benefit of this form of capital is that it is very flexible. Companies can often bend their own rules because of how much control they have over what they ultimately are getting. It's a great choice for companies that are otherwise struggling to obtain their necessary funds.
Exploring Some Drawbacks
The major drawback is that you're going to ultimately get less of the invoice in the long run. You're trading a portion of the long-term face value for an instant infusion upfront. Now that isn't always bad - in fact, it can often be exactly what your company requires - but it's important to remember that when you consider whether to factor a given invoice or not. If your business can sustain without it, it may be more beneficial for you to do so in the longer term even if it means slightly less flexibility in the shorter term.
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