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Letter of Credit and Factoring

Question asked by Sujamol J

Difference between Letter of Credit and Factoring? Whether both can be combined in a single trade transaction? If yes How?

response from Dalila Boinay

Hi Sujamol,

Factoring usually involves the purchase of a accounts receivable of the company (the beneficiary's) by cash. This is usually done when the beneficiary is in immediate need for funds. Once the accounts receivable is purchased by the factor (who lends money to the beneficiary, may be bank of other financial institution), the beneficiary is freed from his obligations. The Invoice Finance company now collects his money from the debtor (the issuing bank).

Now factoring is beneficial to the beneficiary as this does not require the credit worthiness of the beneficiary. The fatoring is done based on the strength of the accounts receivables , not the beneficiary's credit worthiness. This is not a loan but a purchase of assets to clear them off the balance sheet of the beneficiary's company.

Hope this helps.


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