What are the advantages of factoring?
Table of Contents
Advantages of factoring from company point of view
From the view point of the firm, factoring offers the following advantages
1. Collection service
Many firms find it difficult to collect their trade debts. Collection of debts is an important area of credit management and it requires more time. Firms are therefore not able to devote time as they are preoccupied with other activities. Factors purchase book debts of clients at a price.
Debts are assigned in favor of the factor. The factor, through the use of trained man power and sophisticate infrastructural back-up systematically follows up debtors. He makes timely demand on debtors. The debtors are more responsible to the demand from the factor being a credit institution. Credits are collected on time.
2. Assumption of credit risk
Assumption of credit risks is one of the important advantages of factoring. All the trade debts of the customer is undertaken by the factor without recourse. In simple words, the risk of default in customer’s payment is assumed by the factor in factoring.
The client is assured of complete realization of his book debts. Even if the customer fails to pay the debt, the factor pays the amount to the client.
3. Reduced current liabilities
The amount received from the factoring is used to pay off the bank borrowing and other current liabilities comprising trade creditors. As a result, current liabilities are considerably reduced. The liquidity position of the firm is strengthened further.
4. Off-balance sheet finance
When the factor purchases the clients’ debts, the finance is provided off the balance sheet. In recourse factoring, the finance appears in the client’s balance sheet only as a contingent liability.
In recourse factoring, if the customer defaults in payment, the client has to make good the loss incurred by the factor. The factor is entitled to recover from the client the amount paid in advance.
But in case of non-recourse factoring, the finance provided does not appear anywhere in the financial statements of the borrower. The factor does not have the right of recourse.
5. Higher credit standing
With increased cash flows to the client, he is able to meet his liabilities promptly as and when they arise. The factor’s acceptance of the client’s receivables itself is the mark of high quality of the receivables factored. The problem of bad debts does not arise.
6. More concentration on functional areas
In any business, certain proportion of management time has to be diverted in credit control. Only large companies can afford to create a special department for this purpose. But smaller sized units cannot afford it.
A factor undertakes the responsibility of credit control. The client, by utilizing factoring service can devote time to functional areas like planning, purchase, production, marketing and finance.
7. Consultancy service
Factoring creates a close relationship between a factor and a client. By virtue of their specialized knowledge and experience, factors can provide a variety of advisory services to their clients.
For example, customer’s perception of the client’s products, changes in marketing strategies, emerging trends in the market and so on can be brought to the knowledge of the clients.
