The factoring company is a specialized financial institution or a division of a major banking organization. The trading company receives only a portion of the accounts receivable value indicated in its financial statements. Indicatively, this proportion could range from 60 to 90 percent, with a discount factor of 10 to 40 percent. As compensation for this discount, the trading company receives immediate payment from the factoring company, without having to wait for the collection period.
Immediate payment obviously improves the trading company's cash flow and may also reduce the risk of its debtors failing to pay their outstanding invoice (debt). The discounting of receivables is an attractive option for many businesses. It offers numerous benefits. First, it accelerates cash flow, enabling the company to better finance new sales. Second, the company may, at its discretion, continue to offer deferred payment terms to its customers. Thirdly, discounting receivables enables the company to take benefit of any early payment discounts that its suppliers may offer.
Additionally, this procedure enables the company to be agile and swiftly respond to attractive market opportunities. It helps the business avoid the costs associated with offering discounted payment terms to its customers in an effort to speed up collections, and it also helps the business finance significant investments and purchases.
Importantly, the company can continue directly negotiating sales and other terms with customers. A company's relationship with its customers is unaffected by a factoring transaction. In many legal jurisdictions, customers are not required to be notified of this form of transaction. The business may continue to collect receivables (i.e., unpaid invoices from customers) without notifying customers of the change in proprietorship of their debt to the business.
The market for factoring is saturated with financiers, and businesses typically have no trouble finding a suitable financing partner. Some of the larger factoring companies may impose a minimum consumer size requirement. For instance, prominent corporate banks such as HSBC may have a $10 million annual sales cap. If so, businesses with annual revenues below that threshold would be too small to have a cost-effective factoring relationship with HSBC.
Export sales can be a concern, but they need not be a hindrance. Even if some of their sales are exports, businesses may still use them in a receivables discounting transaction. Since these invoices entail collection from an international customer, the financier may discount them more heavily.
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