Factoring is a technique used to realise receivables (invoices) whereby, under a factoring agreement, a business can assign its receivables to a specialist financial institution, called a 'factor'. In exchange for remuneration, the factor provides a set of services to manage the business’ 'accounts receivable' (client accounts).
The factor can meet one or more needs, as decided by the customer:
- the management of accounts receivable;
- the immediate financing of receivables;
- the guaranteeing of invoice payments.
Factoring has several objectives:
- release the business from administrative tasks, allowing it to concentrate fully on its main activity;
- help the business to deal with cash flow shortages (resulting from the terms of payment that businesses give to their customers) and allow it to allocate these funds to the financing of its operating cycle;
- cover the business against the risk of insolvency of its debtors.
By using factoring, businesses can improve their liquidity, solvency and profitability.
Objective: finance short-term receivables.
Who is concerned
Available to the self-employed and any type of business meeting the prerequisites, factoring can be used in the following cases:
- cash flow problems due to long terms of payment given to customers, the issue of large invoices, a relatively long operating cycle;
- significant growth involving high cash flow requirements;
- inadequate administrative structure for managing invoices;
- full expansion or restructuring resulting in a lack of staff to effectively monitor debtors;
- desire for protection against the insolvency of customers, without having to closely monitor their financial health.
Most factors have an extensive international network of correspondents and therefore agree to cover exports abroad (international receivables).
Factoring is only available with respect to the factorable receivables of businesses:
- with a certain level of minimum annual turnover;
- selling standard goods and services;
- with mainly professional customers (companies);
- with a sufficiently wide customer base;
- giving their customers normal terms of payment (i.e. 60 to 120 days);
- with a healthy financial structure.
Invoices payable on delivery, issued to natural persons, or issued to subsidiaries or companies that can offset the debt are therefore excluded.
Documentation or description of the business
- copy of the company’s articles of association;
- group structure if the company is part of a more complex group;
- last 3 audited balance sheets of the applicant and, if applicable, the latest available trial balance;
- recent supporting documentation regarding VAT, tax and social security situations;
- order book (where applicable);
- list of customers and their relative contribution to turnover;
- list of suppliers.
Presentation of the application
- cash flow statement;
- forecast budget showing future working capital needs;
- presentation and analysis of the quality of customers;
- list of invoices;
The factor becomes the owner of the receivable by contractual subrogation. It therefore obtains the rights attached to this receivable and thus has a guarantee covering the advance given to the business. The credit risk, however, is based on the final debtors, i.e. the business' customers – hence the factor's need to check the quality of the debtors and ensure that the customer base is sufficiently wide.
Additional guarantees may be requested by the factor depending on the business’ standing, its turnover and overall financial structure, the extent of the advances to be provided and the quality of the customers. The most common guarantees requested for factoring are:
- credit insurance;
- surety of the parent company or partners/shareholders;
- various moral guarantees.
When the partners/shareholders of a business have to stand surety for the company, the bank should be provided with the details of their financial situation.
How to proceed
Duration and amount
The duration of the factoring is determined in the contract drawn up between the business and the factor. In principle it is a factoring facility until further notice, similar to a cash credit facility.
- generally an advance of 70 % to 90 % of the amount;
- percentage depends on the quality of the customer and the factoring company.
The cost of financing receivables corresponds to the interest that is due for the period from the date on which the funds are made available to the seller and the date on which the debtors pay the factor.
Added to this is a factoring fee which is made up of the cost of the credit insurance and the payment in exchange for the services provided by the factor. It is expressed as a percentage of the amount and varies according to:
- the scope of the services requested;
- the volume of work compared to the turnover to be covered;
- the risk incurred which depends on the economic sector and the customer's reputation.
An advance is repaid on the due date of the invoice when the debtor (buyer) pays the factor.
The reviewing and processing times depend on the complexity, size and urgency of the case.
Advantages, disadvantages and risks
- reduction in cash flow shortages resulting from a gap between the payment of invoices received and the collection of invoices issued;
- professional analysis of the risks relating to the different customers and covering of the risk of insolvency of some customers by credit insurance;
- reduction in the administrative and financial burden associated with the management of accounts receivable;
- transfer of the exchange risk to the factor for invoices issued in foreign currencies;
- greater flexibility in terms of cash flow because of a reduction in working capital needs without increasing the level of debt.
- relatively high cost;
- less personal relationship with customers;
- almost complete disclosure of the business' receivables and thus turnover.
Non-recourse factoring (with credit insurance) for which the factor takes on the risk of the non-payment of invoices:
The only risk for the business is the risk of non-payment by a customer because of the invoice being disputed.
Recourse factoring (without credit insurance):
- the business takes on the risk of non-payment of invoices since the factor has the right to reclaim unpaid invoices from the business;
- the business takes on the risk of non-payment by a customer because of the invoice being disputed;
- the non-payment of an invoice has a negative effect on the business' profit.