If you have ever heard a business representative talk about factoring he is not referring to the mathematical process from school-age classes. The financial world runs on many systems of capital including the three-way system of selling invoices for fast funds that it can use to continue to fuel its growth.
The invoices that are collected each year by an accounts receivable department of a business may be used internally for payroll taxes or any number of other records. The choice for these businesses however is to sell of these invoices to another company who will give them liquid assets in return. The incentive for one company is obvious — quick money is always helpful — but what is in it for the others? Factoring is not a loan or a payback method but rather a simple buying and selling principle of the corporate world. Factoring allows the sale of any particular part of a company’s invoices rather than its completed transactions. When the invoice is sold in this matter it is often less about an actual chunk of money than it is a work to be produced or a good to be given. As such it is necessary to involve another party in this take up the debt and free up the actual money. This triangle is a complex process with the receivable party selling off the invoices the debtor providing the money to the company and the factor who receives the invoices paying the service to the debtor. The factor in this agreement has the right to take in these payments but they will take the loss if the debtor cannot pay out the amount to the invoice sellers. As such the risk is upon the factor in all these parts. The companies purchasing these invoices run the very real chance of the exchange busting but the value of these invoices is so high that it is well worth the investment. Service charges between all three parties are also typical given the amount of paperwork and man-hours that go into the complex exchange making it possible for interest to accumulate after the sales have been delayed. As such many times the factor will estimate the amount that is to be received (and not received) well ahead of time and provides this information to the debtor in order for all three parties to make an informed decision. It is important for three parties to be involved in factoring to avoid direct violation of accounting principle as two parties would involve a sale and then be liable to taxation. With three parties however it is treated as a loan and all received goods or services can be counted as collateral.
Larger firms have the ability to profit from invoices of smaller companies but prefer to manage the exchange indirectly. This is to the advantage of the invoice sellers as they have the chance to gain quick capital and avoid inefficiencies. Factoring as such gives a trio of benefits to several parties though it carries significant risks as well.