Factoring: Meaning and Types (Full Service, Buyer Based, Recourse Financing) | Management

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MEANING
Sometimes it so happens that a firm requires urgent money to either make a payment to its creditors or for expansion of its business

When the firm sells its bills receivables or debtors to a third party in order to get the required money to fulfill its various needs in called the factoring concept. It is a very common activity followed to tackle debts or gain urgent money.

5 IMPORTANT C’s of giving on credit
Character: It includes the things the customer values, the integrity, attitude, behavior of a person. If the seller feels that the so and so person has a good character, he will sell the goods on credit.

Capacity: It includes the customer’s ability to pay the amount in future. Apart from a person’s character, it is equally important to see whether he has the ability to pay back in the future within a stipulated time

Capital: It talks about the customer’s investment in the business. It can include shares, capital equipments etc. if a person has good amount of investments then that person is considered reliable for granting on credit

Collateral: The security the customer can pledge to in case if they fail to pay the amount is something that can be taken into consideration before giving the goods on credit

Condition: The condition of the economy or the customer’s financial condition also. If country is in recession, there is a lot of risk as it is not guaranteed that the customer will stay sound or not

ADVANTAGES OF FACTORING
Timely and speedy arrangement of finance
Factors provide funds Much faster than the banking or Non Banking companies. Factoring companies offer lesser documentation and quick realization of funds as compared to other financial institutions.
No Requirement of Collateral
Unlike cash credit & overdraft, factors do not require any collateral security to be pledged. New businesses or startups can easily avail the advances provided they have strong receivables/debtors

Attention towards further Business Operations and Expansion
By selling off invoices cum debtors, businesses can feel stress-free of the task of collection from the debtors. Resources employed in the receivables department can be directed towards business operations, financial planning etc..

Evasion for Bad Debts
Under without recourse factoring, in case of bad debts, the loss is borne by the factor. Hence, the seller is under no obligation to the factor once it sells off its receivables.
TYPES OF FACTORING
Full Service/ Without recourse: Here the factor or the third party takes the entire risk of bad debt.

With Recourse financing: Here the factor does not take the risk of bad debt. If the debtor fails to pay the payment, the burden goes to the firm.

Buyer Based factoring: The factor selects the buyers on the basis of goodwill and creditworthiness and prepares an approved list of all such debtors.

Meaning of Factoring, Advantages of Factoring, 5 IMPORTANT C’s, Types of factoring, Full Service/Without recourse, With Recourse financing, Buyer Based factoring