Accounts receivable factoring agreement drafts the best financial solution for a successful business. The factoring companies or just 'factors' can be considered to be loan like instruments offering funds and helps in reserving sufficient capital.
This strategy widely used by entrepreneurs as it helps in improving their credit records and assessing their performance. This process also involves paperwork and legal documents and drawn as an agreement.
Factoring Agreement – Overview
- Factoring agreement is a contractual, legally binding agreement.
- It's usually on yearly basis by default one year contract.
- Some companies opt for six month contract and may extend later.
- Very companies choose monthly basis as high fees is levied for shorter durations.
- General practice is to go for a long term agreement as it helps in understanding the finer aspects in detail.
Types of Factoring Agreement
Accounts Receivable Factoring Agreement can be of two types based on the transfer of risk factor…With or Without Recourse.
With Recourse option
- With Recourse option supports transfer of capital but no risk transfer.
- If the customer does not make the payment, the amount has to be settled entirely from your own.
- The company is not accountable for the loss incurred due to clients.
- This option is less expensive but has risks involved.
Without Recourse option
- Without Recourse option supports both transfer of capital and risk factor.
- If the customer does not make the payment, the company will bear the loss.
- Due to the high risk, the fees charged are also higher.
- For selecting which type of factoring is required, analyze first your situation and choose the one that serves better.
Business Factoring Costs
The cost levied for the entire factoring process is known as factoring fee. It consists of multiple components.
Initial Fee
This is the initial fee paid to set up the account for factoring and for processing the application.
Variable payment
It is paid during the transactions and is variable depending on the volume of each transaction.
Discount rate
This is the interest rate applicable on every transaction also known as discount rate. These rates can vary depending on the field in which your business is operating, its present scenario in market, assessment of your invoices, and other financial parameters. These rates can be modified if the customer fails to pay on time.
Securing the Agreement
- There are few clauses protecting the Factoring Company from fraudulent activities and cheating by the customers.
- Also factoring companies insist on getting some tangible security in case of high risk when signing the agreement.
- A detailed study about the company and our needs is essential before going for an Accounts Receivable Factoring Agreement.
- This practice is prevalent and it depends on your financial environment and of the accounts receivable factoring company.
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