[10] Scottish law differs from that of the rest of the UK, in that notification to the account debtor is required for the assignment to take place.
[4][2] The seller sells the receivables at a discount to the third party, the specialized financial organization (aka the factor) to obtain cash.
[1][4][2] This process is sometimes used in manufacturing industries when the immediate need for raw material outstrips their available cash and ability to purchase "on account".
Certain companies factor accounts when the available cash balance held by the firm is insufficient to meet current obligations and accommodate its other cash needs, such as new orders or contracts; in other industries, however, such as textiles or apparel, for example, financially sound companies factor their accounts simply because this is the historic method of financing.
Debt factoring is also used as a financial instrument to provide better cash flow control especially if a company currently has a lot of accounts receivables with different credit terms to manage.
A company sells its invoices at a discount to their face value when it calculates that it will be better off using the proceeds to bolster its own growth than it would be by effectively functioning as its "customer's bank.
[15] The solution to the problem is: where Today factoring's rationale still includes the financial task of advancing funds to smaller rapidly growing firms who sell to larger more credit-worthy organizations.
While almost never taking possession of the goods sold, factors offer various combinations of money and supportive services when advancing funds.
Factors often provide their clients four key services: information on the creditworthiness of their prospective customers domestic and international, and, in nonrecourse factoring, acceptance of the credit risk for "approved" accounts; maintain the history of payments by customers (i.e., accounts receivable ledger); daily management reports on collections; and, make the actual collection calls.
The outsourced credit function both extends the small firm's effective addressable marketplace and insulates it from the survival-threatening destructive impact of a bankruptcy or financial difficulty of a major customer.
In the United States, if the factor does not assume the credit risk on the purchased accounts, in most cases a court will recharacterize the transaction as a secured loan.
Amount of funding can vary depending on the specific accounts receivables, debtor and industry that factoring occurs in.
Factors can limit and restrict funding in such occasions where the debtor is found not credit worthy, or the invoice amount represents too big of a portion of the business's annual income.
It's a compound of an administration charge and interest earned overtime as the debtor takes time to repay the original invoice.
The difference between the face value of the invoice and the advance rates serves to protect factors against any losses and to ensure coverage for their fees.
When a nonrecourse transaction takes place, the accounts receivable balance is removed from the statement of financial position.
English common law originally held that unless the debtor was notified, the assignment between the seller of invoices and the factor was not valid.
[26] In England the control over the trade thus obtained resulted in an Act of Parliament in 1696 to mitigate the monopoly power of the factors.
With the development of larger firms who built their own sales forces, distribution channels, and knowledge of the financial strength of their customers, the needs for factoring services were reshaped and the industry became more specialized.
By the twentieth century in the United States factoring was still the predominant form of financing working capital for the then-high-growth-rate textile industry.
By the first decade of the 21st century, a basic public policy rationale for factoring remains that the product is well-suited to the demands of innovative, rapidly growing firms critical to economic growth.
[28] A second public policy rationale is allowing fundamentally good business to be spared the costly, time-consuming trials and tribulations of bankruptcy protection for suppliers, employees and customers or to provide a source of funds during the process of restructuring the firm so that it can survive and grow.
In the latter half of the twentieth century the introduction of computers eased the accounting burdens of factors and then small firms.
Acceptance of signed documents provided by facsimile as being legally binding has eliminated the need for physical delivery of "originals", thereby reducing time delays for entrepreneurs.
[30] Some companies use technology to automate some of the risk and back-office aspects of factoring and provide the service via a modern web interface for additional convenience.
This enables them to serve a broader range of small businesses with significantly lower revenue requirements without the need for monthly minimums and long-term contracts.
Critics accurately point out that none of these new players have experienced a complete credit cycle and thus, their underwriting models have not been market tested by an economic contraction.
It's unclear if this source of capital will be stable over time, as other companies, most notably, Lending Club, had a difficult time attracting investors in early 2016, even though net returns seem higher on invoice finance platforms such as MarketInvoice[32] and FundThrough[33] than on business loan platforms such as Funding Circle.
The healthcare industry makes for a special case in which factoring is much needed because of long payment cycles from government, private insurance companies and other third party payers, but difficult because of HIPAA requirements.
Factoring companies that cater to this niche offer services to help accommodate drivers on the road, including the ability to verify invoices and fund on copies sent via scan, fax or email, and the option to place the funds directly onto a fuel card, which works like a debit card.