Factoring, derived from the Latin term “factura” for invoice, refers to the sale of a company’s outstanding receivables to a so-called factor. Factoring is mainly used in small and medium-sized businesses and is applied to payments from commercial customers. Factoring is not commonly used for open payments from end consumers.
The factor settles transferred receivables at short notice
Factoring is a financial service offered by a factor. The advantages for the company of using factoring are primarily the short-term provision of financial resources and the resulting increase in liquidity. If outstanding trade receivables are assigned to a factor, the factor usually settles 80 to 90 percent of the outstanding amount within a maximum of 48 hours. The remainder serves as a security deposit, which is paid out as soon as the invoice has been paid in full by the customer, whereby the security deposit is not intended to compensate for the potential payment default. Instead, it is used to grant the customer any discounts that may still be available at a later date or to absorb invoice reductions to compensate for deficiencies. Even if the customer does not pay, the company receives the security deposit after a certain period of time.
Del credere protection with genuine factoring
A distinction is made between genuine and non-genuine factoring. In true factoring, the full default risk is transferred to the factor when the receivable is sold. This del credere protection is not included in non-genuine factoring, where the risk of a receivable not being paid by the customer remains with the company. In Germany, however, genuine factoring including del credere protection is common. It is also common to operate factoring openly. If receivables are sold, the debtor is informed of this. However, there is also the possibility of silent factoring, in which the customer does not learn that his receivables have been assigned.
Advantages of factoring for the company
The use of factoring improves the position of a company. Due to the sale of receivables, the risk of non-payment in genuine factoring is transferred 100 percent to the factor. Even if a customer becomes insolvent, this does not entail any risk for the entrepreneur. In addition to improved liquidity, the rapid provision of receivables from open invoices also brings planning security. Discounts can be claimed and investments can be made at short notice. The organizational effort in the company is also reduced, since with full-service factoring the accounts receivable accounting, the dunning process and the potential collection are transferred to the factor. The increased liquidity and the resulting reduction in liabilities also have a positive effect on the balance sheet, which in turn leads to an improvement in the equity ratio. This gives the company a better starting position namely lenders for credit negotiations and the provision of larger sums. The creditworthiness of customers is also constantly monitored. As compensation for its services, the factor charges fees that vary according to the amount of work involved. However, these costs are often offset by synergy effects resulting from factoring.
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