For a person who first heard the word "factoring", it will seem something very complex and intimidating. However, its essence is quite simple, and in modern business it helps to solve a lot of problems.
Non-standard bank financing
Although factoring is not a classic type of lending, it is one of the forms of financing.
To understand what factoring is, its types and implementation schemes, is quite simple, you just need to understand its essence.
There are several definitions that fully reveal the meaning of factoring operations:
- loans secured by receivables;
- financing secured by future contract revenue;
- lending under the assignment of rights of a monetary claim under a contract.
In terms of sense, they distinguish both factoring with recourse (the definition of the variety and its essence are set forth below) and financing, which does not provide for the right to repurchase debt from the buyer.
Use this type of lending offer both banking institutions and specialized factoring companies.
Potential clients
Factoring financing may potentially be of interest to companies selling goods or performing services on a deferred payment basis with their counterparties. This will allow them to avoid cash gaps in activities and increase production volumes.
Of course, factoring will be the ideal solution for those organizations that set themselves the goal of expanding the sales market, and dependence on prepayment as a form of settlement does not allow this.
Factoring Loan Scheme
The stages of financing are as follows:
- Negotiating with the buyer of goods or services regarding the possibility of transfer of rights under an agreement concluded between the contractor and the customer.
- Conclusion of a factoring agreement with a banking institution.
- Notifications to the buyer of the assignment of claims under the contracts by sending a letter or by signing an additional agreement.
- Implementation by the seller of the shipment of goods or the performance of services and works, which are accompanied by relevant documents (invoices, acts of work performed).
- Submission of shipping documents or acts to the bank.
- Bank transfer to the seller’s account of a partial amount of future revenue according to the submitted documents.
- Upon the expiration of the postponement period for the contract that was transferred to factoring services, the buyer settles by transferring money to the account of the financial institution.
- The bank returns the balance of the amount according to invoices or acts to the supplier’s account.
Choosing a factoring agent
What should I look for when choosing a company that will be a factoring service provider?
First of all, this is the cost. Factoring, like any type of lending, is a paid service. Its price is higher than classical bank financing due to the lack of collateral in the form of a “hard” collateral and, accordingly, the bank’s higher risks. However, if you find a bank that offers factoring in the framework of cooperation with its customers, it will cost less than with third-party organizations.
The size of the advance payment, which implies the amount of money that will be transferred to the seller upon the submission of shipping documents to the bank, each financial institution has its own size.Its run-up can be from 50% to 90%.
In the factoring agreement, it is worth paying attention to the existence of a buyback right, which provides for the ability to repay the advance payment previously issued by the bank by the buyer. This makes it possible to save interest on future payments. And it’s good if such a right is provided in the contract as a voluntary desire. It happens that this clause in the contract is stipulated in the section "Obligations".
Varieties of factoring and their difference
The most exciting question for those who decided to use this form of financing is: "What will happen if the buyer does not pay me in a timely manner or refuses to pay at all?" As already noted, there is such a type of factoring as factoring with recourse. It implies the right of the bank to demand from the seller payment of previously paid financing, if it has not been received from the buyer within the agreed period.
The difference between factoring without recourse and recourse funding is the lack of the ability of a specialized institution to recover the amount of debt from the supplier if the customer has violated the payment terms of the contract. In this case, the bank will cover this debt in its account at the expense of its income or reserves.
If we just talk about factoring with and without recourse, then the presence of this opportunity means that the financial institution has the right to the opposite of the requirement to reimburse the amount previously paid to the seller. It is worth noting that in the first case, the cost of this banking service will be lower than in the second.
Pros and cons of factoring with recourse and without for the parties to the contract
It also matters to the bank which service to sell to the client. The difference between factoring with and without recourse for a financial institution is that on whose shoulders lies the risk of non-repayment of debt by the debtor. And in the absence of the right to recover money from the buyer, the factor very carefully approaches the choice of the client.
For the supplier, an option that does not provide for the possibility of a reverse requirement is very beneficial. However, for him, the difference in factoring with and without recourse can be felt in the higher price of a financial transaction and the minimum amount of the first tranche. The bank reinsures itself and pledges partial coverage of possible losses due to the increased interest rate in case of non-payment of debt by the customer. The specifics of factoring with and without recourse is that in the first case a more significant amount of the advance payment is assumed, which for the seller can be up to 90% of the total debt. And this kind of financing is more popular in the financial market.
Another difference between factoring with and without recourse is that in the first version, along with the money transferred in advance, the seller additionally receives a service from a financial institution in the form of information support and accounting for receivables. In the option when there is no buyback right from the bank, the debt is completely transferred to the factor, and there is no possibility of being informed.
Business Factoring Benefits
This type of financing has many advantages compared to classic lending:
- The absence of additional costs for registration of collateral.
- Minimum package of documents to consider the issue of setting a limit.
- The possibility of expanding sales markets for the seller and the list of suppliers for buyers.
- Additional verification of the reputation of the debtor by the bank.
- Possibility of entering European markets.