Companies that are considered a high-risk customer for a traditional bank loan may find it advantageous to factor its receivables. Factoring can provide much needed cash to a company that cannot qualify for traditional financing by selling an asset (the receivable) for operating cash. Factoring is considered to be an expensive alternative to traditional financing due to the high discount rate applied to the receivable when it is purchased by the factoring service compared to traditional financing rates.
Reduced Exposure to Bad Debt
Selling receivables to a factoring service is an effective way for a company to reduce its bad debt expense. While the company selling its receivable must realize the loss of potential cash receipts by selling the receivable at a discount, its has also eliminated the possibility of non-payment on the account. This is essentially a risk-reduction effort aimed at controlling bad debt expense.
Financing Alternative
Obligation factoring is a usage behaviour to develop cash flow.Obligation factoring is the system whereby a partnership sells an asset, primarily its receivables, to another business. Obligation factoring is recurrently used as an shakedown by a convention to rid its bag of what it has deemed as noncollectable receivables, although some firms prefer to sell their receivables soon after placing the object on their aging statement. This channels is quite accepted and provides assorted advantages.
