Factoring of Debtors (Receivables): Meaning, Advantages and Disadvantages

Factoring of Debtors (Receivables)

This is the sale of a firm’s debtors to a financial institution known as a factor for immediate cash. The firm and the factor agree on the basic credit terms for each customer.

The customer or the debtor is normally notified of the arrangement and will be required to pay directly to the factor. The factor charges interest on the amount advanced and service fee or commission of other services rendered.

Advantages of a factoring

1. Enables the company to pay its suppliers on time hence enabling the company to take advantage of discounts offered by the suppliers.
2. The company obtains funds from the factor to finance its working capital items.
3. The factor saves the management time and the problem of debtor’s management.
4. It enables the company to finance its growth through sales instead of injecting new capital.

Disadvantages of factoring

1. The amount received from the factor is less than the actual value of debtors hence making factoring expensive.
2. Since the debtors will make payments directly to the factor, it will represent a negative image about the company.
3. The factor is likely to take over the customers who are credit worth and leave those who are not credit worth to the company.