Factoring
Traditionally, companies which needed to raise finance from their receivables sold them to either a bank or a third party in a process called Factoring. There are two now types of factoring - selling invoices to just one organisation and selling invoices to the market.
Factoring - invoices sold to one organisation
Factoring, is a financial transaction in which a business sells its accounts receivable invoices to a third party, called a factor, at a discount in exchange for receiving cash immediately. Unlike bank loans, the risk assessment by the factor, the lender, is on the value of the receivables and the buyer's credit rating, not on the business's credit worthiness. The factor is not making a loan; it is purchasing the invoice(s), a financial asset and takes ownership of the receivable typically including all the risk of bad debt, although in some cases the factor has recourse, in which case, the seller is liable for any bad debts the factor cannot collect.
In a factoring transaction, the factor advances a percentage of the invoice face value (typically 80-90%) which is paid to the seller upon receipt of the invoice. When the invoice is paid the remainder of the total invoice is paid less the factor's fee. This fee is normally made up of a service charge, and an interest based charge based on how long the factor must wait to receive payments from the debtor.
Factoring typically involves a transfer of complete accounts receivable management to factoring company, including the processing of collections. Most factoring is performed on a notification basis where the seller has to notify customers that the account has been sold because the payment has to be remitted direct to the factor.
The main benefits of factoring are that it releases cash and improves cash flow, although the receivables are sold at a discount. A full factoring service also saves time in the accounts department as it eliminates invoice ledger management and the need to chase late payments. Factoring is more suitable for smaller companies that do not have the resources to be able to manage their own account receivables.
Factoring - invoices sold to multiple institutions
In 2010 a new way for selling receivables was launched, instead of just selling receivables to one factor a platform was launched that enabled suppliers to sell their receivable invoices directly to many institutional investors in a real-time, competitive auction process.
The seller uploads the receivable invoices for sale and sets up the auction specifying the closing date, the minimum advance, and the maximum fee they are prepared to accept. The seller also has the option of setting a buyout price, which will win the auction instantly (similar to the Buy it Now option on eBay). The auction must be approved by the platform and must be for a minimum amount which can be made up of multiple invoices. The auction is posted online where buyers are able to check the background of the seller and can see the details of all the invoices. The bidding process enables buyers to estimate how competitive their bids are and the seller to monitor the auction in progress. An auction typically takes less than 24 hours, sometimes less than two hours.
The funds are wired to the seller's bank account the next business day. The platform charges suppliers a one-off registration fee, and both the buyers and suppliers a low % fee on the value of the transactions.