Asset-based factoring involves selling assets, such as payment invoices, to a factoring firm for immediate payment. The factoring company pays a percentage upfront and the rest, minus a fee, once payment is received from debtors. This allows businesses to maintain cash flow without credit checks. Factoring fees depend on factors such as creditworthiness and volume of business.
Asset-based factoring occurs when a business sells its assets to a factoring firm in exchange for an immediate payment. In most cases, the goods in question are payment invoices from other companies that have received goods from the business without making immediate payment. The factoring company will advance a large percentage of the invoice amount to the firm and then pay the rest, less a small discount fee, once full payment has been received from the debtor. Using asset-based factoring, businesses can ensure a steady cash flow without having to endure the credit checks that come with applying for a business loan.
For a business, finding ways to generate cash to sustain day-to-day operations is critical. This money can be hard to come by, especially if he has established credit relationships with the other companies he does business with. One way for a business to avoid the cash flow problems associated with long delays between delivery of goods and payment by debtors is asset-based factoring, which involves a third-party factoring firm prepaying cash and collect payments.
As an example of how asset-based factoring works, imagine Company A sells a product to Company B for $2,000 US Dollars (USD), and Company B plans to pay based on a credit agreement with Company A. Company A then contacts a factoring company, who agrees to purchase the invoice and pay the company 80% of the amount upfront. The remainder will be held in reserve by the factoring company until it can collect payment from company B. Once payment is received, the factoring company will pay the remaining amount to company A, less a 5% discount fee.
This means that Company A will receive the immediate payment of $1,600 USD from the factoring company. Once Company B pays the factoring company, Company A will receive an additional $300 USD, which is the reserve amount minus the 5% discount fee. The factoring agency receives the discount fee, which amounts to $100 USD, for its services.
How far a factoring company will go on an asset-based factoring deal and what fees they will charge depend on several factors. The factoring company will likely check the creditworthiness of the company’s debtors and the volume of business the company does before setting fees. Additionally, the nature of the deal may determine fees and down payment rates. In particular, if the firm is not held liable by contract for credit defaults by its debtors, the fees charged by the factoring firm will be relatively high.
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