Factoring is a solution that frees companies from the collection management of their invoices and has as its main value the financing of commercial credit.
What is factoring? Definition and how it works
That is to say, the financial companies that offer it not only take care of the procedures to collect on the established dates but also consider the advance payment of the money from the invoices.
In other words, the definition of factoring is the decision of a company to outsource collection management, transferring its commercial rights (invoices, promissory notes, work certifications, etc.) in favor of a financial institution.
Its name comes from the term factor, which represents the finance company.
The factor is responsible for assessing the risk of each operation. This will be determined by the solvency of the assigned clients, as the ultimate responsible for paying the invoices.
It depends on whether the financial institution approves the request and also determines the cost of the service. The higher the risk, the higher the cost.
Through this formula, a company can request various types of services.
Common factoring services:
Financing. The factor makes advances for the transferred amounts. It can be through an account system, such as a credit policy, or through a discount system (commercial discount).
In the discount, the interest is paid in advance at the time of receiving the money. The rate is applied to the nominal amount requested and can be fixed or variable (depending on the term until the expiration of the invoices).
Payment management. It includes all the collection procedures for assigned invoices, saving time and costs for companies.
Risk coverage. The factor can assume the risk of non-payment of the invoices and take care of the claim. The company would be covered from any insolvency of its client.
Additional services: control of loans and client portfolio, advice, etc.
The Factoring contract
For an entrepreneur, the main objective of a factoring or factoring operation is the assignment of his commercial credit to obtain fast financing in the short term.
The agreement is formalized as a service contract and can be freely negotiated as it is not subject to specific regulation.
The parties involved in a factoring contract are:
Assignor: company that assigns the rights to collect your invoices.
Factor: company that accepts the assignment and offers the financing service.
Debtor: client of the transferor and obliged to pay the invoices.
The signatories are the transferor and the factor.
The contract establishes the obligations of each party according to the contracted services. Specifically, the form and limits of the advances, and the interest rate, commissions or other financing expenses.
The transferor must deliver the original documents. You can assign the invoices you want but it is common to take advantage of the principle of globality and agree to the assignment of all the invoices of a client or with a certain volume.
Thus, more efficient management is achieved and more liquidity is obtained.
Types of Factoring
The main contractual modalities or types of factoring are distinguished by notification and risk coverage:
Advantages of factoring:
The benefits of factoring for companies are related to the services contracted. In general terms, these are the most relevant advantages:
Greater efficiency in the management of collections. You save time and resources to dedicate to the business.
Strengthens liquidity. Increase financing capacity by obtaining cash quickly and easily.
Improve treasury planning. The cash inflow is better mastered: dates and amounts, which also has an impact on greater control to correct deviations.
Strengthens the accounting balance, by improving the management of current assets and their turnover. Avoid external indebtedness due to lack of cash.
Reduces the risk of delinquency, defaults, insolvency or bankruptcies.
It favors the management of the client portfolio and the control of billing. Helps make better business decisions.
It supports the presence in foreign markets, avoiding complicated procedures due to the payment conditions of each country.
Ultimately, with the support of a good factoring company, organizations improve their financial structure and avoid commercial risk.
- Last three account statements
- Complete credit application
- Driver’s license
- Void check from business account
- Invoice work orders
- Invoices receivable
- Company insurance
- Articles of Incorporation
- Company EIN
- Work contract related to invoices