Factoring Definition

by Investing School on October 4, 2009

In order to increase or improve cash flow, companies may sell their accounts receivable to a factor or agent at a discount. This is known as factoring. In the present economic downturn, factors are very busy. They assume the debt of the strapped company and manage the accounts. When entering into a factoring agreement, the indebted company uses their invoices as collateral for cash, usually provided by a factor in a short-term loan.

A line of credit from a banking institution does not provide as much cash flow as a factoring agreement does because with this agreement you are borrowing on your sales which helps to finance more growth.

This arrangement increases your cash flow as well as making the management of your cash easier since there is more predictability now that you don’t have to depend exclusively on payments from customers to keep your business flowing.

This is also known as accounts receivable financing.

Accounts receivable are bills that are owed by customers that have already received the goods or services provided for by a company. Accounts receivable is considered an asset because any bills owed a company are a legal obligation on the part of the company indebted to the owed company.

Almost all business is run by extending credit to companies and individuals considered low risk. When too much credit straps a business, executives enter into a factoring agreement.

Factors make money in these arrangements because they buy a company’s accounts receivable at a discount and whatever profits are generated.

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