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The sale of accounts receivable, also known as factoring, is a method adopted by companies to gain access to cash immediately. When goods are sold by a company, the buyer usually does not pay for them immediately; to eliminate the waiting period the company sells the invoices to a third party that immediately pays the seller in cash with a portion deducted as its fees. The third party is then responsible for collecting funds from the buyer.
Selling of receivables is used by companies that cannot approach banks for loans as their credit rating is not good. The credit worthiness of a company is not established merely from the value of goods sold by it but also includes its assets and liabilities. Loans are also not sanctioned immediately but take time for due process by lenders. The company that has sold the goods on the other hand may require immediate access to cash to repay its immediate liabilities.
Selling of receivables is also a way by which companies are guaranteed cash for the goods sold with the risk of the buyer defaulting being passed on to the third party that buys the invoices from the company that has sold the goods.
A disadvantage of this practice is that the seller does not get the complete value of the goods sold as around 20-30% is deducted by the party buying the invoices as fee for the service provided.
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