Factoring

What it means

Factoring is the purchase of receivables before their due date. The factor advances most of the invoiced amount at once and the remainder after the customer pays, charging a fee plus interest for the funding period.

It splits by who carries the risk of non-payment. Under recourse factoring the risk stays with the supplier, who must buy the invoice back if unpaid; under non-recourse the factor takes it, and the price is higher.

Factoring differs from forfaiting in scale and repetition. Factoring is a framework agreement for an ongoing flow of short-term invoices from several customers; forfaiting is a one-off purchase of a larger, usually longer-term receivable, often from exports and secured by a bill of exchange or a letter of credit. Both, however, rest on assigning the receivable to a third party.

How it works in practice

It makes sense where customers pay on 60 or 90 days while the company must buy materials and meet payroll meanwhile. It addresses the same problem as an overdraft, but is tied to specific invoices rather than to the company’s overall standing.

In the books the receivable leaves the sub-ledger and the fee goes to financial costs. With recourse factoring the treatment follows the contract, since the risk has not actually left the company.

Before the contract is signed we go through with the client which customers the factor will accept and with what limit. A factor usually funds only customers with good creditworthiness, so the problem payers that made the company want factoring in the first place are often left out. Each month we reconcile the factor’s statements with the sub-ledger so that advances, balances and fees match specific invoices.

What to watch out for

Factoring is not cheap and does not replace credit management: a company that sends no reminders and never checks customer standing simply pays more for the same problem. The customer also learns of the assignment, which is not always welcome.

Contracts with large customers sometimes exclude assignment of receivables without consent. Assignment is governed by the Civil Code, and an agreement with the debtor that excludes it makes the assignment invalid. The company then answers to the factor for a receivable it could not actually sell, and risks a dispute with its own customer as well.