Page 179 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Advantages

The following advantages relating to the facility of factor:
1. Factor ensures certain pattern of cash-in-flows from credit sales.
2. Elimination of debt collection department, if it is continuous goes factoring.

Limitations

Apart from the services observe by factor, the arrangement suffers from some limitations:
1. Services would be provided on selective accounts basis and not for all accounts (debts).

2. The cost of factoring is higher and compared to other sources of short-term working
capital finance.
3. Factoring of debt may be perceived as an indication of financial weakness.

4. Reduces future sales due to strict collection policy of factor.

Self Assessment

Fill in the blanks:
1. ………………..may broadly be defined as the relationship, created an agreement, between
the seller of goods/services and a financial institution called the factor
2. Banks provide working capital finance through financing …………………

11.2 Features of Factoring

The following are the salient features of the factoring arrangement:
1. Factor selects the accounts of the receivables of his client and set up a credit limit, for each
account of receivables depending on safety, financial stability and credit worthiness.
2. The factor takes the responsibility for collecting the accounts receivables selected by it.
3. Factor advances money to the client against selected accounts that may be not-yet collected
and not-yet-due debts. Generally the amount of money as advances to 70 per cent to 80 per
cent of the amount of the bills (debt). But factor charges interest on advances, that usually
is equal to or slight higher than the landing rate of commercial banks.

Did u know? What is difference between factoring and a bank loan?
Factoring differs from a bank loan in three main ways.
1. The emphasis is on the value of the receivables (essentially a financial asset), not the
firm’s credit worthiness.
2. Factoring is not a loan – it is the purchase of a financial asset (the receivable).
3. A bank loan involves two parties whereas factoring involves three.
The use of factoring to obtain the cash needed to accommodate the firm’s immediate cash needs
will allow the firm to maintain a smaller ongoing cash balance. By reducing the size of its cash
balances, more money is made available for investment in the firm’s growth. A company sells
its invoices at a discount to their face value when it calculates that it will be better off using the

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