Reviewed by Jan 29, 2021| Updated on
The factor immediately advances much of the sum invoiced to the client and the rest to the invoiced party upon receipt of funds. A transaction involving a factor involves three parties directly—the factor that buys the receivable, the purchaser of the receivable, and the debtor, who has to make a payment to the owner of the invoice.
A factor helps a company to acquire immediate capital based on potential profits due on account receivable or company invoice owing to a specific sum. Accounts receivable (AR) act as a record of money which customers owe for credit sales. Factoring helps other interested parties to buy the funds owed in return for supplying cash upfront at a discounted price.
Depending on their internal activities, the terms and conditions set by a factor may vary. Factoring is most often achieved by third-party financial institutions, which are referred to as factors. Factors typically release funds linked to newly acquired receivable accounts within 24 hours. The terms of repayment may vary according to the amount involved.
Additionally, the sum of funds received for the actual account receivables, known as the advance rate, can also vary.
Factoring is not called a loan, as the parties who are part of the agreement neither question nor obtain debt. Often, the funds made available to the company in exchange for the accounts receivable are not subject to any use limits.
The method of factoring can be divided into two parts—initial account setup and continuing funding. It ideally takes a week or two to set up a factoring account. It involves applying, a list of clients, an account receivable ageing report, and a sample invoice.
The approval process includes thorough underwriting at which time the factoring company may request additional documentation, such as incorporation papers, financial statements, and bank statements. If approved, the company will be formed with a maximum line of credit from which they can draw.
If the account has been set up, the firm can start invoices for funding. Invoices are not individually accepted, but most invoices may be funded within a business day or two, as long as they follow the requirements of the criterion.
Receivables are funded in two parts. The first element is the "advance" which includes the invoice value from 80 to 85 per cent, deposited directly into the bank account of the company. The remaining 15 to 20 per cent will be rebated, minus the factoring costs, as long as the invoice is charged to the factoring company in full.