Factoring

Everything you need to know

What is Factoring?

What does liquidity planning have to do with factoring?

Liquidity planning plays a central role in corporate planning. For this reason, many companies increase their own liquidity by taking advantage of outstanding invoices and providing additional cash flow with the help of factoring. This form of liquidity management is characterized primarily by the fact that companies sell their outstanding receivables from services and products to factor companies. As a rule, long-term cooperation with these factor companies is generally sought.

Diagram explaining factoring

Who is factoring useful for?

In this way, the factoring provides for a permanent increase in the solvency of a company. It is therefore particularly suitable for small and medium enterprises and represents a particularly flexible financing option in liquidity management. Although factor companies also often provide the skills of a debt collection agency, factoring is not to be understood as a collection performance.

What is factoring?

Factoring is mainly used for improving cash flow used within a company. This concept provides a huge relief, particularly for small and medium businesses. Frequently, these companies have sufficient sales in principle, but sometimes still fall into financial difficulties. This comes primarily from the fact that, even with legitimate claims against a cash customer, a company often has to wait more than 30 days to settle the claim.

In many cases, this enormous delay already has a negative effect on the solvency of small and medium-sized companies. Additionally, there is a lack of payment discipline for some customers and a surprising reduction in lines of credit. There is also the possibility of an increase in operating costs, which may result in the failure of a company's liquidity management. For this reason, alternative sources of funding are often used short-term to provide for a higher liquidity within the company. In this way, liquidity management is improved and restored with its own solvency.

Basic Characteristics of Factoring

Factoring stands out primarily by the three following basic characteristics:

  • Factoring basically describes the sale of outstanding receivables to a factor company. As a rule, a long-term contract is concluded, which transfers the default risk of all outstanding claims on the factor. For this reason, factoring usually represents a long-term cooperation.
  • The pre-financing of all claims eliminates the waiting time between invoicing and payment. Immediately after the invoice, the factor makes an upfront payment to the seller. This usually corresponds to between 80 and 90 percent of the pre-funded account. The balance will only be paid if the customer has followed their payment obligation.
  • Ultimately, factoring is also characterized by the fact that the factor for the selling company handles all affairs of the debt management. In addition to the accounts receivable system, this also includes reminders and checking the customer's credit rating. Furthermore, all debt collection matters also fall within this range. In this way, the selling company will take the entire dunning.

The Different Forms of Factoring

Real and “unreal” factoring
In practice, there is a distinction between real and fake factoring. With fake factoring, as opposed to genuine factoring, no transfer of default is at risk. This means that the sum paid must be refunded in full if the claim is not paid by the customer.
Full service factoring
This classic factoring uses mainly SMEs: financing, disaster protection, and complete accounts receivable management relieve the vendor completely.
Maturity factoring
Furthermore, a so-called maturity factoring is also partly offered. Under this, the factor merely takes over the debt collection matters. In addition, this form of factoring provides the amount due only after the buyer's payment. Thus, the financing function is completely eliminated.
Inhouse-Factoring
Ultimately, there is also the so-called in-house factoring. Here, the dunning remains fully in the selling firm. The factor is absolutely discreet in this case. The factor advances only when the third reminder was unsuccessful. However, the selling company continues to enjoy full credit protection.
Open factoring (Notification factoring)
The vendor informs the customer about the factoring of the debt. This knowledge allows debtors to efficiently claim action against them. Specifically, debt in open factoring can be reduced only by payment to the factor.
Non-Notification factoring
The vendor does not inform the customer about the factoring of the debt. Consequently, customers do not react to turning the factor. After all, factoring is synonymous with the word "collection".

What advantages and disadvantages arise for a company by factoring?

Advantages of factoring

The increased liquidity obtained and increased through factoring improves:

the equity ratio.
In the same breath, the balance sheet and the long and medium-term credit quality are improved. Even with a planned loan application, small and medium enterprises that use factoring experience better cooperation
protection against bad debts.
If delinquencies by default on the part of the customers are not enforceable, the loss is due to the bad debts of the factor company. The selling company then benefits and customer insolvency is protected against financial losses.
the fixed costs.
Dunning and Accounts Receivable require personnel. The time consumed in credit management resources can result in fixed costs. Factoring the entire dunning is moved to the jurisdiction of the factor company, saving the selling factor takers personnel costs, time, resources, and fixed costs in the long term.
the company's growth
The use of a factor company not only bridges financial problems, but is also used mainly for growth purposes. Factoring is a relatively risk-free way for companies to invest in their own business growth.

Disadvantages of Factoring

Factoring offers attractive advantages to many companies, but is also associated with some disadvantages:

  • The factor increases in the case of customer default in payment. This may adversely affect the customer relationship.
  • Factoring is not always suitable for all industries. In some industries, the factor company does not assume the receivable.

Does your company have outstanding customer invoices? Take advantage of the numerous benefits offered through our factoring alternative. Schedule a personal consultation with our dedicated staff today.