Factoring is often understood by businesses to be invoice discounting. However, it is, in fact, the sale of receivables, whereas invoice discounting is borrowing, where receivables are used as collateral.
In recent years, factoring has experienced substantial growth, as it has become an important source of financing for both small and medium-size enterprises (SMEs), as well as for export corporations.
Factoring is provided by financial institutions, for example banks and individual factoring brokers. It is a form of asset-based financing, where the factor provides funding based upon the values of a borrower’s accounts receivable, i.e. corporate debtors. The receivables are purchased by the factor rather than used as collateral for a loan. This means that the ownership of receivables shifts from the seller to the factor. Factoring generally includes more than just financing, and it also includes funding and collection (Booth and Cleary, 2007).
Factoring and invoice discounting in the UK is being used by more than 47,000 companies, with a total volume of €170,000 billion in 2003 (Bakker et al., 2004). It is a popular method of working capital management in many countries, and is especially helpful for start-up companies, as well as small and medium-size corporations, to use their working capital more effectively.
Factoring offers some advantages for the factor over lending, and is likely to become more important in transitional and developing countries. The funding provided to the customer is explicitly linked to the value of their underlying assets (working capital), and not to the borrower’s overall creditworthiness. This portfolio of assets (receivables) is being continuously managed, to ensure that the value of the underlying assets always exceeds the amount of credit.
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