True sale

What is True Sale in Financial Factoring?

A true sale is a key concept in the world of financial factoring. It refers to a transaction where a company sells its receivables to a factoring company. This sale is "true" because it is a complete transfer of ownership. Once the sale has occurred, the original company no longer has any rights to the receivables.

The Importance of True Sale

In financial factoring, a true sale is crucial because it determines the risk allocation. After the sale of receivables, the factoring company assumes the risk of non-payment by the debtors. The selling company benefits by getting immediate cash and removing these receivables from its balance sheet.

How True Sale Works

Let's break it down: A business sells its products or services on credit. It generates invoices, which are promises of payment from customers. In a true sale transaction, the business sells these invoices to a factor - a factoring company. The factor then immediately pays the business a large portion of the invoice value. The factor takes on the responsibility of collecting payments directly from the customers. After collection, the factor pays the remaining balance to the original company, minus a fee for the factoring service.

Benefits of True Sale to Businesses

Businesses often prefer a true sale for several reasons. It provides instant cash flow, reduces collection efforts, and can improve financial statements. With the factoring company taking on the credit risk, businesses can focus on their core operations. They also get protection against bad debts, as the risk of non-payment is now with the factoring company.

Legal Considerations of True Sale

For a transaction to be considered a true sale, it must meet certain legal criteria. It's essential the sale is irrevocable, and that the seller has no obligation to repurchase the receivables. Legal opinions may be sought to ensure that the sale meets all the requirements of a true sale, which helps to prevent any disputes over ownership of the receivables.

True Sale vs. Loan or Advance

It's crucial to distinguish a true sale from a loan or an advance against receivables. In a loan or advance, the selling company still owns the receivables and remains responsible for the credit risk. This is not the case with a true sale, which is why understanding this difference is vital for companies considering financial factoring.