Asset-based factoring involves selling assets, such as payment invoices, to a factoring company for immediate payment, with the factoring company collecting payment from debtors. This allows businesses to maintain cash flow without credit checks. The amount advanced and fees charged depend on factors such as creditworthiness and liability for debtors’ credit default settlement.
Asset-based factoring occurs when a company sells its assets to a factoring company in exchange for immediate payment. In most cases, the assets in question are payment invoices from other companies that have received goods from the company without immediate payment. The factoring company will advance a large percentage of the invoice amount to the business and then pay the remainder, minus a small discount fee, once full payment has been received from the debtor. By using asset-based factoring, businesses can ensure steady cash flow without having to endure the credit checks that accompany applying for a business loan.
For a business, it is crucial that it finds ways to generate cash to maintain daily operations. This cash can be hard to come by, especially if you have established credit relationships with the other companies you do business with. One way for a company to avoid the cash flow problems associated with long time periods between delivery of goods and payment by debtors is asset-based factoring, which involves a third-party factoring company that advances 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, which agrees to purchase the invoice and pay the company 80 percent of the amount up front. The remainder will be held in reserve by the factoring company until it can collect payment from Company B. Upon receipt of payment, the factoring company will pay the remaining amount to Company A, less a 5 percent discount fee. .
This means that Company A will receive an immediate payment of $1,600 USD from the factoring company. Once Company B pays the factoring company, Company A will receive $300 more, which is the reserve amount minus the 5 percent discount fee. The factoring agency receives the discount fee, which amounts to $100 USD, for its services.
How much a factoring company will advance on an asset-based factoring arrangement and what fees it will charge will depend on several factors. The factoring company will likely verify the creditworthiness of the company’s debtors and the volume of business the company does before setting the fee. Additionally, the nature of the agreement may determine fees and anticipated fees. Specifically, if the company is not liable for its debtors’ credit default settlement, the fees charged by the factoring company will be relatively high.
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