The Purpose Of Accounts Receivable Factoring

by erin on February 18, 2011

By selling the accounts receivable of a company to a debt collecting agency, the business can rid itself of a liability and generate an influx of cash to at least cover costs or a necessary expense. Sometimes an organization is not sure it will be able to collect an amount owed to them. Sometimes they need to obtain cash quickly. Accounts receivable factoring can enable both.

When a company does not immediately require payment for a good sold or service rendered, it will allow the receiving organization or person to establish an account. This is known as accounts receivable is a liability to that company. It requires time and materials to produce the good or service, for which they anticipate recovery plus a profit.

The collectability of an account will become more questionable the greater the amount of time that it remains unpaid. Usually terms are established as 30, 60, 90, or 120 days. This means the person or entity has that long in which to pay what it owes. However, if the account has not been at least partially paid by 90 days, a company begins to worry it may not be paid at all.

So as to not be subject to the maximum amount of loss, many businesses will sell delinquent accounts to a factor. This allows them to cover, at least partially if not in full, what was spent on materials and labor. In some cases, depending on how much the debt was sold for, the organization may still be able to realize a partial profit. The loss is reduce to a minimum, therefore. If the bad debt is written off, this is not the case.

When a business sells its accounts receivable to an agency to allow them to attempt to collect the debts owed, it is selling to a factor. This organization purchases the accounts at a discounted price, or less than the total amount owed to the business. It will then try and collect the full amount, therefore turning a profit.

A company may be low on cash, but have its own bills coming due that it needs to pay. Using a factor can be a means to produce this cash rather rapidly. The total offered to pay for the receivables may make this method less costly than borrowing for purposes of payment.

A business does not always have the amount of time needed to allow the paperwork for a loan to be processed. It may not be given advantageous terms or a low interest rate, either. When this is the case, particularly with low amounts, a factor may be a much better option than incurring debt from a lender.

Using an accounts receivable factoring agency allows a business to at least partially recover amounts that were promised to be paid when a good or service was provided. This rids the books of the possibility of bad debts and can produce an influx of cash if necessary with asset based funding. The factor will then own and attempt to collect the full amount of the debts, lessening the headache of the initiating organization.

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