What is factoring?

What is factoring?
Definition

Factoring is a common business practice for corporate financing. Normally, it is effected in the framework of a general agreement. The regular sale of accounts receivable constitutes the core of factoring. In this process, the company sells a claim against a customer, i.e. an open invoice, to another company. The latter is referred to as a factor, factoring company, or factoring institute. It becomes the owner of the claim and asserts it against the customer. Because of overlapping activities and competences of debt collection companies, factoring and debt collection services are often offered from a single source.

 

What is factoring?
Components

In addition to the sale of receivables, which is also referred to as receivables assignment, factoring also comprises other components, with "del credere" forming one important criterion. This is defined as the assumption of a guarantee for the debtor's solvency by the factoring company. This means the factor assumes the risk if the customer fails to make payment in the end.

Moreover, pre-financing is also part of factoring. If a company has a justified claim against a customer, it often has to wait for the due payment for some time. Under a factoring agreement, this waiting period does not apply, as the factor pre-finances the claim for the customer. This means that, depending on the respective contract, the company receives a large part of the money to which it is entitled right away rather than after 30 days or more. Pre-financing rates of 80 to 90% are common, with the company receiving the remainder of the account once the customer or debtor has made the payment. 

Accounts receivable management constitutes the third element of standard factoring. This includes accounts receivable accounting, regular credit checking of the customers, dunning, and debt collection. The factoring company provides these services for its customers. For example, as a result, the factoring customer does not send out reminders, as the factor provides these services for it. This is also where we see overlapping activities and competences with debt collection companies.

What is factoring?
the advantages

Today, companies of all sizes are using factoring as a means of financing. As a result, they can increase their liquidity. The company now has more funds at its disposal. Rather than having to wait for the payment of claims, it receives the funds arising from an order right away. This has a number of positive effects. Increased liquidity also improves the equity ratio, the balance sheet and - in the medium to long term - even the company's credit rating. If a company wants to apply for a loan, factoring increases its chances. Moreover, factoring protects against bad debts. If the outstanding claim cannot be collected, e.g. because of the customer's insolvency, the factor bears the loss because of the del credere. Accounts receivable accounting and dunning lie within the factor's responsibility. As a result, the company does not have to use any staff, time or other resources for it.

What is factoring?
the subtypes

Some companies do not wish to outsource certain departments, such as dunning, which is sensitive. In this case, in-house factoring is the right solution.