Get to know the whats and whys of business invoice factoring
You might have heard of the phrase business invoice factoring. In layman’s term, this is called factoring finance. We have to focus on the word "factoring" to get the whole picture of what this phrase means in the business world. Factoring, basically, is a financial transaction wherein a company offers its account receivables for sale to other businesses or company. These receivables are usually sold at a discount. The one which buys these account receivables is called a factor. This is the third party who, in a way, indirectly finances a business to continue its operations – through factoring.
Invoice factoring is one way for corporations to finance their operations and business activities through management of their working capital and receivables. Its importance is highlighted when companies are in dire need of capital by looking into their balance sheets, selling the receivables, and converting these into working capital which will directly finance the operations of their respective businesses.
There are usually three parties involved in factoring: these are 1) the debtor, 2) the factor, and 3) the company who sells the receivables. Usually, the factor (the one who buys the receivables) acquires all the rights which attach to the receivables. The factor also assumes the risks involved with the negotiated receivables.
Initially, factoring finance was first conceptualized during the latter part of the 1300s. This was in part due to financial transaction problems encountered in international trade during that time. As time went on, more reliable trading systems were made and thus helped in the evolution of the factoring system either by developing the original system or adding some important improvements to business invoice factoring.
In a factoring transaction, there are usually three parts. These are: 1) The advance, 2) The reserve, and 3) the fee. We must take into consideration the meaning of these three parts in order to comprehend how business invoice factoring truly works. The advance is the invoice’s percentage face value which is usually paid upon submission to the seller of the accounts receivables. The reserve, on the other hand is the total invoice remaining amount. This is held until after the account debtor has made his payment. The fee covers the transaction cost of factoring. The reserve is usually deducted with the transaction cost before being paid pack to the seller.
As with most financial products, business invoice factoring has its risks also. One of these risks is called counter-party risk. This is a factoring risk which is associated with doing business with a third party or factor. Fraud is also one of the common risks in factoring which can be attributed to fake invoices used for the transaction. One has to learn fully well the agreement between two contracting parties to avoid financial losses due to these risks.
The world of business has now become even more complicated in terms of doing business transactions and company operations. There are many things that should be taken into consideration on the management aspects of a company’s day to day operations. Focus should be given to managing business finances well; and one of these is factoring finance for a company relies on the liquidity of its finances or assets in order to sustain its business activities for a long period of time.