In order to address short-term liquidity needs, businesses sometimes turn to factoring, which is a slightly different approach than invoice financing. Factoring can be categorized into four main types: maturity factoring, finance factoring, discount factoring, and undisclosed factoring. It is important to note that the terms and nature of factoring may vary depending on the financial institution involved. The advance rate, which represents the percentage of the total invoice amount provided upfront, can range from 80% to approximately 80-95%. Once the factor collects payments from the debtors, it reimburses the remaining funds to the business after deducting its fee or commission.
Factoring offers the advantage of allowing companies to address their liquidity needs promptly, without having to wait for two or three months, by approaching a financial institution. To better understand the concept of factoring, let's consider an example. Imagine you own a business and have outstanding accounts receivable that will not be due for another three months. However, you require immediate access to cash to meet urgent liquidity needs.
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