The Basics of Factoring
Having cash in your bank account is critical for SME’s to survive and grow.
But, how to release the cash value locked up in your Balance Sheet?
Factoring, also known as receivables finance, invoice discounting, or debtor financing is a financial process where companies can sell their outstanding invoices for cash.
A third party, known as a factoring company, buys some or all of the accounts receivable from the company and takes responsibility for collecting the money owed.
This process enables companies with large outstanding accounts receivable to access cash quickly and maintain their cash flow. The process is known as invoice discounting because the factoring company will charge a fee for the service. Thus, the company that sells its invoices will not receive the total amount — the discount — but does access the cash much more quickly than it otherwise would have.
The process
The company seeking cashflow will apply to a factoring company and submit details of the invoices owed. If the factoring company agrees to take on the debt, they will pay a deposit on the invoices, immediately releasing some of the accounts receivable value in cash.
The factoring company will then seek payment on the invoices, taking on the risk that the invoices will be paid in full. Once the invoices are paid, they will pay the remainder of the balance to the company, minus the factoring fee or discount.
The Pros and Cons of Factoring
The most obvious benefit to a company is the ability to generate immediate cash flow. While accounts receivable may be an asset on the company balance sheet, it is not accessible cash. In addition, delays between outgoing and incoming payments can cause significant headaches for companies.
Additionally, there is always an associated cost with maintaining a healthy accounts receivable situation and the human and technical resources required to chase payment on outstanding invoices. However, for a company with a good credit history, factoring can provide a predictable cost for managing receivables.
Factoring, however, is not perfect. For smaller companies or companies with less-than-perfect credit histories, factoring companies will charge higher fees to hedge their risk. Companies needing cash will have to make an opportunity cost decision if given those circumstances.
Enter Defactor
The FinTech revolution, and the evolution of decentralised finance, are opening a swath of new opportunities for FinTechs and Family Offices to provide new sources of finance to small and medium-sized companies. Traditional banks are becoming more restrictive especially in the areas of cashflow finance so blocking the growth of these businesses. Defactor is leading the way through by providing a funding platform for Fintechs / Family Offices. Potential asset classes that qualify for financing include accounts receivable, inventory, supply chain, and purchase orders.
This same revolution also provides an opportunity for investors, or liquidity providers to participate in funds that enable this type of finance. These investments are often short-term and provide reliable yields protected from the general financial outlook.
In future articles, we will discuss how the world of DeFi, and the blockchain, are revolutionizing trade finance, and Defactor’s leading role in that change.
About Defactor
Defactor, a global leader in decentralized finance (DeFi), helps innovative companies to access this new connected economy with confidence. As one of the first platforms to put real-world assets onto the blockchain, Defactor enables asset originators and investors to easily join and build a stronger financial future. By leveraging our integrated platform, the native $FACTR token, and a broader ecosystem, Defactor provides a seamless and secure process that supports the ambitions of our clients, investors, and communities.
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