Factoring is a financial practice in which a company sells its accounts receivable (invoices or other receivables) to a bank or a financial institution specialising in factoring, known as a factor. The factor, in turn, buys the invoices at a discount to their nominal value, thus providing an advance of funds for the selling company, typically 70% to 90% of the value of the invoice. When the customer pays the invoice, the factor passes on the balance (30% to 10%) to the company that sold the invoice, less the agreed discount and any fees for the service provided. In other words, factoring allows companies to obtain immediate cash in exchange for their accounts receivable, without having to wait for the payment deadlines agreed with their customers. In this way, the selling company obtains capital to finance its operations, while the factor profits by receiving the full amount of the invoices from the debtors when they pay, which is a higher amount than they paid for the purchase of the invoice.
By using factoring, the company transfers the right to receive payments on invoices to the factor (the entity that buys the invoice), which assumes, or not, the risk of non-payment by the debtors, depending on whether the factoring is done without recourse or with recourse.
In the case of non-recourse factoring, the risk passes to the factor because, if the customer fails to pay the invoice, the company that issued and sold the invoice is not obliged to assume the debt and repurchase the invoice. In this case, the responsibility for collecting the invoice necessarily passes to the factor.
Factoring with recourse implies that, despite the sale of the invoice, the risk of non-payment of the invoice remains with the company that issued and sold the invoice, since if the customer doesn't pay the invoice the company has to assume the debt by repurchasing the invoice, so it remains ultimately responsible for collecting the invoice.
Factoring is commonly used by companies facing cash flow difficulties due to late or extended payments from customers, or who have capital "tied up" in invoices due to long payment terms or customers who pay slowly.
Traditional factoring involves the negotiation and conclusion of a contract between the transferor company and a bank or financial entity specializing in factoring. Banks and factoring organizations usually require a very high minimum volume of invoices to be included in the contract, usually in the region of several hundred thousand euros, which in many cases means including all of a company's accounts receivable or at least all of the accounts receivable from large clients. In addition, factoring can include additional services such as managing accounts receivable, collecting amounts owed and analyzing debtors' credit. However, it is important to emphasize that the characteristics and terms of factoring can vary according to the country and the negotiations between the parties involved.
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