Accounts Receivable Factoring Definition
What Does It Mean?
What is the correct accounts receivable factoring definition? If you are new to the topic chances are you have been hearing a bunch of terms being loosely thrown all around.
Accounts receivable factoring is also commonly referred to as invoice factoring, business factoring or simply the selling of accounts receivables.
There are typically two parties involved in the transaction, the business and the Factor.
The Factor, or Factoring company is the company who buys the accounts receivables from the business in exchange for cash.
Why would a business want to sell its accounts receivables?
Because by doing so, it can get the cash it needs to grow today instead of later when its customer pays.
Basically, the Factoring company pays the business a percentage an amount smaller than the amount of the receivable. The company pockets the difference as their profits.
Why should the company profit? Because they are taking the risk. If the customer doesn’t pay, the Factoring company loses out, not the business.
Is accounts receivable factoring common?
It has become popular over the recent years are businesses are finding ways to accelerate their cash flows.
Another way to think about factoring is that you as the business are outsourcing your invoice collection process for a small fee, only you are getting to collect on the money owed to you much quicker.
So who is accounts receivables factoring for?
Any business looking to expedite cash flows or wanting to secure growth capital to expand operations.
Think about this scenario for example. A customer owes you $20,000 and promises to pay 60 days later. However 20 days later there is a big fair in town and you know you can sell three times the volume you normally do.
You want to capitalize on this opportunity but don’t have the funds lying around to invest in inventory that you can sell. What do you do? You sell the $20,000 to an accounts receivable factoring company.
It will cost you a bit of money (let’s say 5%), but what if you can make a return on investment of 15%? That is still a net 10% in your pocket.
I hope this quick run-down on the accounts receivable factoring definition clearly explained what is accounts receivable factoring.