What is a factoring service?

The need for liquidity has led to financial innovation between businesses as firms seek ways of remaining profitable. This article briefly describes what a factoring service is and what it involves. Read this article to know more.

Financial process

A factoring service is a financial process in which a firm sells its invoices to a service provider that gives them cash at discounted rates. The service provider then has the responsibility of approaching the actual debtor for payment, saving the original firm from the trouble of chasing payments. The purpose of factoring services is to avail immediate cash for ongoing business in a firm. Procedure Essentially, the procedure involves three parties: the firm that redeems the invoice (the creditor), the firm that owes on the invoice (the debtor) and the service provider (the factor). The firm that redeems the invoice with the factor benefits by gaining funding for business immediately. This enables the company to address pressing business needs. However, it loses out by selling the invoices at a discount in this process. Benefits The factor benefits by redeeming the invoices with the debtor at normal rates, gaining a profit above the discounted rates. However, it exposes itself to risk because some firms may inordinately delay payments. The venture does not affect the debtor since his payment on the business invoice is usually the same, regardless of who presents it. The only drawback is an increase in the risk of exposure to uncooperative factors.

Three stages

The transaction usually involves three stages. First, the creditor receives an advance from the factor, that is a percentage of the face value of the invoice. Second, the creditor receives a reserve, which is the remainder of the amount owed by the factor in the transaction. This usually comes after that the debtor clears the amount that is owed on the invoice. Last, in the process of paying the reserve, the factor deducts the service charges or interest payments based on the length of time that he has waited for payment. Factoring services Factoring services are a form of invoice funding that increase the liquidity of a company, especially when cash flows are limited. The process is legal and is guarded by law in some jurisdictions.