Once mainly used by large companies, but nowadays spreading across all organisations, debt factoring is a very well-established form of funding. In simple terms, it is a short-term way for a business to release funds that are blocked in the form of unpaid trade receivables by selling those debts on to a third-party factoring company at a discount.
Debt factoring is particularly suitable to industries in which the production process is characterised by consistent delays in receiving payments for goods sold and services delivered. Import and export, wholesale and distribution, and logistics are examples of sectors that make extensive use of debt factoring.
To illustrate how this tool works in practice, think about a situation in which customers of a trucking company named Flash Trucks take up to two months to pay their bills. A delay in receiving payments such as this could create serious issues for Flash Trucks and could ultimately affect its ability to function properly. For example, how can it continue to maintain its fleet of lorries or pay for fuel and drivers? With factoring, the organisation can be assured that they will receive payment for its services and continue to operate normally between the point of sale and the point at which its customers will pay.
The typical process of factoring is outlined in Figure 1. Click on each step in the figure to read about how debt factoring works in practice.