Final answer:
When a company is experiencing cash flow difficulties and opts to sell its receivables to a third party for instant cash, this is known as factoring. It enables businesses to manage cash needs without incurring debt, but comes at the cost of selling the invoices at a discount.
Step-by-step explanation:
If a company is experiencing cash flow difficulties, it may opt to sell its receivables to a third party to generate cash. This is known as factoring or accounts receivable financing. Businesses may use this strategy to quickly access money without waiting for the actual payment terms to finalize, which can take several weeks or months. In the process of factoring, a company sells its invoices at a discount to a third party, which then assumes the responsibility for collecting the payments from customers.
Companies often need to manage their cash flows effectively to ensure they can cover day-to-day expenses, such as payroll, rent, and inventory. Selling receivables allows a company to meet its immediate cash needs without taking on additional debt. This can also be particularly useful in times of recession, when maintaining cash flow is critical, and the risk of loan defaults is higher. However, it's important to consider the cost of factoring, as the discount on the receivables will affect the company's bottom line.