For up and coming businesses, making sure that they keep liquid assets is very important. To keep themselves competitive, many businesses offer sales on credit to their customers. In accounting terms, these customers become the company’s debtors. An Accounts Receivable account is created, which records all of the debtors of the company. While an income is generated on every credit sale, there is no cash flow until the customer pays for his goods. This can be troublesome for a small business, as cash flow becomes an important part of the working capital. While larger companies can sell millions on credit (they can afford to), smaller businesses must maintain as much as liquidity as possible. This is why they may opt for factored accounts receivable services.
What Is This Service About?
The Accounts Receivable/Debtors account of every company is the account in which a list of all the debtors is maintained. At every quarter, the account is closed, and at the end of the year, the closing balance is published in financial statements. For investors, a high figure in the accounts receivable can be alarming; it shows that the business isn’t generating a lot of cash flow. This in turn affects the working capital of the company, affecting day-to-day operations.
By opting for factored accounts receivable services, a company sells its list of debtors and gets financing for it. It is a type of asset financing in which a funding company provides an immediate injection of cash to the company. The funding company uses the receivables of the company as collateral in the transaction. Compared to the value of the factored accounts receivable, the amount of money received by the company is lesser.
How Does Factoring Work?
If a company has a closing balance of $100,000 in its accounts receivables account, they may get anywhere between 80% and 85% of that amount from a factoring company. The receivables pledged and the amount received is never the same because the financing company now assumes the risk of collection of the factored accounts receivable account.
Usually, a financing company analyzes different aspects before providing an accurate rate of exchange. One major point of consideration is the age of the receivables. For instance, if a company has receivables which are a year older, it is likely that a provision for doubtful debts has already been created against them. This indicates that the company does not expect to recover the money itself. Thus, if the accounts receivable are older, the financing company is unlikely to offer a higher rate of exchange. In order to recover these amounts, factoring companies commonly employ third party recovery agencies, who visit customers and retrieve the money.
