Meaning of Factoring
In this case the business shifts the responsibility of collecting the outstanding amount from the debtors on payment of a specified charge and can take advance money from the bank against the amount to be realized from the debtors.
Merits of Factoring:
1. Cheap source:
Obtaining funds through factoring is cheaper than financing through other means such as bank credit.
2. Quick payments:
With cash flow accelerated by factoring, the client is able to meet his/her liabilities promptly as and when these arise.
3. Flexible:
Factoring as a source of funds is flexible and ensures a definite pattern of cash inflows from credit sales. It provides security for a debt that a firm might otherwise be unable to obtain.
4. No charge on assets:
It does not create any charge on the assets of the firm.
5. Relief of payments:
The client can concentrate on other functional areas of business as the responsibility of credit control is shouldered by the factor.
Limitations of Factoring
1. Expensive:
This source is expensive when the invoices are numerous and smaller in amount.
2. Higher interest:
The advance finance provided by the factor firm is generally available at a higher interest cost than the usual rate of interest.
4. Customers’ Advances
Sometimes businessmen insist his customers to make some advance payment as a part of the payment towards sale price of the product(s), which will be delivered at a later date.
5. Loans from Unorganized Sectors
Businessmen always have the option to take the money from the moneylender (called indigenous bankers), friends and relatives. Since the interest charged on loans from unorganized sector is normally very high, the businessmen are not very interested to avail of loan from this source.