Factoring is a business transaction that converts a companies accounts receivable (AR) or other assets into cash. When a debtor owes a company for goods and services and the debtor gets terms to pay over time, 90 days until payment is due, the small business may run into a cash crisis if it is a big dollar AR. To eliminate the immediate crisis the company could sell the AR asset to a 3rd party thus converting it to liquid cash. However, the factor (the buyer of the AR) will want to buy the paper at a discount and it will be substantial. If the AR is used as collateral for a short term loan this is a different type of transaction.
Cash flow is the life force for a business. Without cash flow the business will stall and may ultimately fail. So in desperate times when a company must improve their liquidity position asset sales may be the only answer. If a company is owed $100m for goods and services and they need cash now, but it will be 90 days until payment is received because of the negotiated terms, the AR asset can be sold. If it is sold to a factor they will never pay 100% of the amount owed because of the associated risk. There is risk associated with the purchase of another companies assets, especially if it is a future event of a promise to pay a debt. What if the debtor does not pay their bill? What if they only pay a portion of the AP bill to the new owner of the asset (the factor) and need more time to pay the balance? These are the questions a factor (the 3rd party buying the AR asset) will have to factor into their offer for the asset. and if they offer a company cash for the AR it will be at a discount. So the $100m account receivable may only bring $50m in cash from a factor.
Any business could never survive factoring as a long term strategy since the assets are always sold at a discount, more commonly referred to as selling the asset for a loss. In a typical business model you have a total cost and a specific profit margin. When selling corporate assets in a factoring model the discount on the asset will almost always be less than the cost, so factoring can only be utilized once in a wile to raise cash and improve immediate cash flow. No company could ever sell all of their assets over and over again at a loss and stay in business. Factoring is a temporary solution to raise money quick but is never a long term strategy.
Cash flow is the life force for a business. Without cash flow the business will stall and may ultimately fail. So in desperate times when a company must improve their liquidity position asset sales may be the only answer. If a company is owed $100m for goods and services and they need cash now, but it will be 90 days until payment is received because of the negotiated terms, the AR asset can be sold. If it is sold to a factor they will never pay 100% of the amount owed because of the associated risk. There is risk associated with the purchase of another companies assets, especially if it is a future event of a promise to pay a debt. What if the debtor does not pay their bill? What if they only pay a portion of the AP bill to the new owner of the asset (the factor) and need more time to pay the balance? These are the questions a factor (the 3rd party buying the AR asset) will have to factor into their offer for the asset. and if they offer a company cash for the AR it will be at a discount. So the $100m account receivable may only bring $50m in cash from a factor.
Any business could never survive factoring as a long term strategy since the assets are always sold at a discount, more commonly referred to as selling the asset for a loss. In a typical business model you have a total cost and a specific profit margin. When selling corporate assets in a factoring model the discount on the asset will almost always be less than the cost, so factoring can only be utilized once in a wile to raise cash and improve immediate cash flow. No company could ever sell all of their assets over and over again at a loss and stay in business. Factoring is a temporary solution to raise money quick but is never a long term strategy.
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