A buying agreement under which a person or entity such as a corporation acquires outstanding debts, invoices, or accounts receivable at a discount from another entity, usually a company, is called a factoring arrangement.
Selling goods or services to consumers or other companies on credit, companies generate outstanding accounts payable. Sometimes they choose to factor their debt by entering into a factoring arrangement with other parties. As for this their outstanding accounts receivable are cleared, although at a discount, and another company is responsible for the recovery of the monies owed. The factoring arrangement is an excellent way for many companies. This helps to leverage that capital and put it into usable form, especially in high volume industries with large amounts of creditors.
Unfortunately, there may be bad debts or other hindrances to collection of the funds. That's why, the factoring arrangement can be a risk for the factor assuming the invoices. As a result, factors have begun running credit checks and assessing the financial health of potential clients before entering into a factoring arrangement. And clients also provide annual reports and other indicators of financial health to factors before they are approved. A credit line is established by factors with clients. Factors often dictate the amount of credit that their clients can offer to customers.
There are two types of factoring arrangements. When the factor remits payment after the client has shipped goods to customers will be the example of the first type. It is called "advance" arrangement. The second one is a "maturity" or "collection" arrangement. Here the factor pays for invoices in chunks, either on the posted due date or when the invoices are purchased by the factor. Sometimes customers are notified that the invoices have been transferred to a factor and instructed to remit payments accordingly.
Nevertheless, this is not always the case. Sometimes clients don't know that their invoices are involved in a factoring arrangement.
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