10.6 Debt factoring

Question 1

What is debt factoring?

Answer 1

A financial agreement whereby a business sells all or selected accounts receivables at a price lower than the resale value to a third party (known as the factor) who takes responsibility for collecting money from the customers.

Question 2

What are the two types of debt factoring?

Answer 2

1 With recourse - the borrower maintains control over the receivables and collects from customers
2 Without recourse - the factor maintains control and bears the responsibility for bad debts

Question 3

What are the advantages of debt factoring for short term finance?

Answer 3

• provides an immediate source of finance
• useful to rapidly expanding companies as it leaves other lines of credit open
• start-ups can benefit where they cannot currently access other sources of credit
• the factors’ credit control systems can be used to asses the creditworthiness of customers and suppliers
• reduces probability of bad debts
• non-recourse factoring allows for insurance against bad debts

Question 4

What are the disadvantages of debt factoring for short term finance?

Answer 4

• factoring can be expensive
• outsourced debt collection can put-off potential customers and suppliers and damage relationships
• company risks losing control over receivables
• company bears the risk of non-payment