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Companies generate accounts receivable by selling goods or services to their customers on credit.Many companies who extend credit to their customers...
Companies generate accounts receivable by selling goods or services to their customers on credit. Many companies who extend credit to their customers sell their accounts receivable to a factor. A factor is a specialized financial intermediary who purchases accounts receivable at a discount. Under a factoring agreement a company sells or assigns its accounts receivable to a factor in exchange for a cash advance. The factor typically charges interest on the advance plus a commission. The price paid for the receivables is discounted from their face amount to take into account the likelihood of uncollectibility of some of the receivables.
Factoring is a technique used by companies to manage their accounts receivable and provide financing. Typically companies that have access to sources of financing that is less expensive than factoring would not use factoring as source of credit.
A factor may provide any of the following services:
- Investigation of the credit risk of customers of the client;
- Assumption of the credit risk of customers;
- Collection of the client's accounts receivable from customers;
- Bookkeeping and reporting services related to accounts receivable;
- Provision of expertise related to disputes, returns and adjustments;
- Advancing or financing.
There are numerous types of factoring arrangements. Some of the basic types vary the treatment of credit risk assumption and customer or debtor notification. When the factoring agreement involves the purchase of accounts receivable where the factor bears the risk of a customer or debtor failing to pay the client for reason of financial inability it is a non-recourse or without-recourse agreement. In the situation where the client must bear the risk of nonpayment due to financial inability, the agreement is a recourse agreement. In many instances, factoring agreements provide for accounts to be purchased on both a recourse and non-recourse basis depending on the credit worthiness of the customers or the debtors.
Is factoring a good option for an organization to control receivables? Please explain.