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Factoring Receivables

Invoices constitute a large portion of a company’s asset and the largest in some companies. Companies often need cash to meet current debts and obligations while waiting for the debtors to remit payments. For companies which are not efficient in debt collection, factoring their accounts receivable to another firm that is specialized in debt collection known as factor can be an effective alternative.

The factor is a company that buys a business’s invoices at a discount and takes responsibility for collecting the payments due on them. Factoring provides a ready source of easily obtainable cash to a business. The decision whether or not to go for factoring is a considered one. If the rate of return from the cash obtained from factored receivables when invested in the production process exceeds the cost incurred in factoring the receivables, then factoring remains a better option.

Once the receivables are sold to the factor at a discount, the factor assumes ownership of the receivables and takes on the responsibility of obtaining payments from the debtors by billing them directly. The factor enjoys the rights to receive the payments as well as bears the risks of loss if the debtors default on payments. This is known as non-recourse factoring as the factor faces the risk of non-payment of the invoices. Recourse factoring on the other hand retains the risk of bad debt with the client and the factor has the right to be reimbursed in the event the invoice remains unpaid. The factor’s profit is determined by the receipts from the debtors over the price paid for the invoices and the loss suffered due to non-payment.

In factoring, the factor manages its client’s sales ledger and does the collection of the outstanding debts. On receiving the client’s invoices, the factor issues cash advances of up to 80% or 90% of the invoice total. The balance less the charges is paid when the factor collects payments from the debtors. The charges made up of service charge which is a percentage of the invoices and an interest charge for the cash advances. The percentage tends to be low when the company that factors the debts undertakes to reimburse the factor for accounts which prove uncollectible.


Example:

A company factors its accounts receivable worth $100,000 to a factor who charges 5% on it. This means the company has sold its debts for $95,000 and the factoring service charges amount to $5,000. In the company’s books, the following general journal entry is made.

Date
Accounts
Folio
Debit
Credit



$
$
20XX




Sep 29
Cash

95,000


Factoring Charges

5,000


Accounts Receivable


100,000

(Factoring receivables worth $100,000)



The above entry of accounts receivable of $100,000 has to be correctly credited to the debtors accounts in the sales ledger that are factored.

Last Updated (Friday, 29 October 2010 20:11)