When it comes to taking precautions and reducing credit risk there are a number of tools you can use. Factoring is one of them.

Factoring is a financial tool where a third party (factor) can buy a business’s invoices at a discount. Take note however that factoring is not the same as invoice discounting. Factoring is the sale of invoices, rather than borrowing that uses accounts receivable as a loan or collateral. Factoring is also known as ‘accounts receivable financing’.

Why is factoring a useful financial tool?

Factoring can be a useful financial tool for companies who need immediate cash to operate their business and meet their immediate commitments. Invoices can have payment timelines of anywhere between 30 and 120 days. This is a long time to wait for your money and can have negative impacts on the smooth operation of other business areas e.g. paying salaries.

Benefits of factoring

There are 6 main benefits to using factoring. These are:

  1. Improving cash flow.
  2. More time to focus on business growth as management of collections is done by the factor.
  3. Your company is not under scrutiny. Factoring is based on your customers' credit and history and not your own.
  4. Factoring can be used as and when to give you necessary cash flow when you need it most.
  5. No interest will be added and there is no debt; factoring is not a loan.
  6. Factoring is scalable. This means that as your business grows so can the amount of funding.

How much can you expect to receive and when?

The factoring provider will pay a percentage of the invoice to the seller, normally within 24 hours. This gives the seller quick access to cash, so they can continue business operations such as processing customer orders. Typically, the advance rate is between 80% and 95% of the invoice value. This variation is dependent on specific measures including who you choose as your factor, your industry and your customers credit history.

Who is in involved in the factoring process?

There are three parties involved in the factoring process:

  • The factor who purchases the invoices.
  • The seller of the invoices.
  • The debtor who has a financial obligation to pay the invoice.

The factor, who has purchased the invoice at a discounted rate, then has the legal right to collect the unpaid bill from the debtor.

With or without recourse?

When a factor purchases an invoice, they can do so with or without recourse. With recourse allows the factor to collect the unpaid invoice from the seller, however, without recourse means that if the debtor doesn’t pay the invoice, the factor will have to take the loss and deal with the unpaid debt.

How do returns effect the factoring process?

If a debtor decides to return some or all the product/s received or cancel the service being provided, assuming it is within the returns and refund policy, then the outstanding amount on the invoice will, of course, be less.

Returns and refunds are the responsibility of the seller therefore, a factor may decide to hold back a certain amount of the invoice (factors holdback receivable) to cover this potential difference. Once the returns and refunds deadline has expired, the factor can then pay the seller the monies that were held back.

More information

Do you think factoring would be a useful tool for your company? Want to know more about how factoring can help you? Get in touch with us today. Our team of international lawyers can assist you.