Debt factoring is a financial arrangement by which a business sells its invoices to a third party at a discount. Businesses use debt factoring to improve their cashflow.
A debt factoring arrangement involves a business selling its invoices at a discount to a factor, which is a specialized third-party finance company. The factor first evaluates the business, to understand how it operates and assesses the receivables to determine whether they are collectible. These are key factors when it comes to drawing up the agreement and calculating the discount. The factor then processes the invoices, collecting the accounts receivables from customers.
Advantages of debt factoring
Debt factoring allows businesses to receive cash immediately for invoices on their books without having to wait for customers to pay. They can use this cash to help them grow. Debt factoring provides a cost-effective collection method because the business does not have to use its resources to pursue and collect receivables.
Disadvantages of debt factoring
A disadvantage of debt factoring is that it can be an expensive financing arrangement because the discount may make it more costly than other types of financing. The factor may also be able to exercise an influence on the business, for example, by choosing the customers or changing the sales strategy.