General Form of Factoring Agreement - Assignment of Accounts Receivable
Description
Key Concepts & Definitions
Factoring Agreement: A legal arrangement where a business sells its accounts receivable (invoices) to a third party (a factor) at a discount. This is typically done to improve cash flow quickly. Assignment: This refers to the act of transferring rights or property from one party to another. In the context of factoring, it involves the assignment of the receivables from the original creditor (the business) to the factor.
Step-by-Step Guide on Factoring Agreement Assignment
- Identify the Need for Factoring: Assess your company's cash flow needs and determine if factoring is a suitable solution.
- Choose a Factoring Company: Research and select a reputable factoring company familiar with your industry.
- Negotiate Terms: Discuss the terms of the factoring agreement, including advance rate and fees.
- Execute Agreement: Sign the factoring agreement once all terms are confirmed and understood.
- Assignment of Receivables: Assign your eligible invoices to the factor as per the agreement.
- Receive Advance: The factor provides an advance on the receivables, typically 70-90% of the invoice value.
- Repayment by Customers: The factor collects payment directly from your customers on the invoices issued.
- Receive Residual Payment: Once the customer pays, the factor will send the remaining balance to you, minus their fees.
Risk Analysis
- Dependency Risk: Over-reliance on factoring can inhibit internal credit management processes.
- Customer Relationships: Direct interaction between your customers and the factor might impact customer relationships negatively.
- Fees: Costs associated with factoring can be higher than traditional financing, affecting profitability.
- Contractual Obligations: Non-flexible terms might lock the business into unfavorable long-term commitments.
Best Practices
- Vet the Factor Thoroughly: Verify the factoring company's credibility, ask for references, and read reviews.
- Maintain Transparent Communications: Keep your customers informed about the involvement of a factor to manage their expectations and preserve trust.
- Regularly Review Your Agreement: Continually reassess the terms of your factoring agreement and its impact on your business finances.
- Consider All Costs: Always factor in all associated costs when evaluating the financial benefits of these agreements.
Key Takeaways
Factoring agreements can be a strategic tool for improving cash flows but come with inherent risks such as potential negative impacts on customer relationships and high costs. Understanding the general form of factoring agreement assignment and adhering to best practices can mitigate these risks and harness the benefits effectively.
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FAQ
What Is a Factoring Agreement? A company and a factor enter into an agreement in which the factor purchases a company's accounts receivable (such purchased accounts are called factored accounts), collects on the factored accounts, then pays the company the purchase price of the accounts.
The simplest definition of accounts receivable is money owed to an entity by its customers. Correspondingly, the amount not yet received is credit and, of course, the amount still owed past the due date is collections.
The purpose of assigning accounts receivable is to provide collateral in order to obtain a loan. To illustrate, let's assume that a corporation receives a special order from a new customer whose credit rating is superb.
What is a Notice of Assignment? The Notice of Assignment is a simple letter that the factor company will send to your customers whose invoices you are factoring.
It is not uncommon that companies with cash flow problems or those that have a desire to be paid on expedited terms assign their accounts receivables as collateral for a secured loan or they factor them.In the case of factoring, the contractor sells its accounts receivable to the financial institution or the factor.
At the point of delivering the goods or services, the company debits Accounts Receivable and credits Sales Revenues or Service Revenues. When an account receivable is collected 30 days later, the asset account Accounts Receivable is reduced and the asset account Cash is increased.
The factoring company pays you the bulk of the invoiced amount immediately, typically up to 80-90% of the value, after verifying that the invoices are valid. Your customers pay the factoring company directly.The factoring company pays you the remaining invoice amount minus their fee once they've been paid in full.
Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution.The borrower pays interest and a service charge on the loan and the assigned receivables serve as collateral.