Factoring is an interesting, credit-like financing option for companies. But how does it work exactly and what types are there? We will explain to you whether this is also a possibility for you based on the advantages and disadvantages as well as the alternatives.
What is factoring?
According to GRADINMATH.COM, factoring works in a similar way to a loan. A company simply sells its receivables from customers to a third party, usually a credit institution.
There are several types of factoring, of which “real” and “spurious” are the main types. They differ mainly in the transfer of the risk, which is transferred to the so-called “factor” in real factoring , but remains with the supplier in fake factoring .
With factoring, you can quickly increase your liquidity and improve your finances if necessary . Factoring occurs particularly frequently in the dunning area, where the claim against the debtor is sold to a debt collection company, for example.
The three main areas of factoring
- The del credere , i.e. the assumption of a guarantee for the debtor’s solvency, which ultimately shifts the risk to the “factor”.
- The pre-financing of receivables by the “factor”, as this is paid immediately to the selling company. However, a maximum of 90% will flow, the remaining claim will only be paid later when the debtor has paid in full (minus the factoring fee and factoring interest).
- The factoring company can also handle accounts receivable for companies. It takes care of the accounts receivable and continuously checks the creditworthiness of the customers. In addition, there is the entire dunning and collection area.
Factor – who is that?
The factor is the company that buys outstanding debts from companies or private individuals. This factoring company or factoring institute is called a factor. The factor buys the claim, although it can be proven that this claim also exists legally, and then asserts it in turn against the debtor. Because this goes hand in hand with other services provided by debt collection companies, the factor is often a company that offers factoring and debt collection services at the same time .
According to the law, the factor providers (“financial services institutions”) are subject to strict regulations. For example, the Banking Act (KWG) or the Money Laundering Act (GWG) apply to them and they are only allowed to conduct their business with the permission of the Federal Financial Supervisory Authority. In addition, their activities are monitored by this authority and the Deutsche Bundesbank.
How does factoring work?
The factoring process can be broken down into a few steps, which we will explain to you in simple words below.
Step 1: Make demands
First of all, you need to bill your customer. It doesn’t matter whether it’s goods or services. It is only important that you issue an official and legally correct invoice to the customer. This invoice represents the claim or the factoring item.
Step 2: Contact the factoring provider
Choosing a good factoring provider can be time-consuming, as there are so many of them. With so many choices, however, it’s easy to find one that exactly suits your needs. We’ll introduce you to the best providers below in the article. As soon as you have selected a suitable provider, you will contact them.
Step 3: The factor checks the receivable and the customer
Before the factor buys the claim from you, it definitely checks the so-called verity of the claim. It is important that the claim is right and that you have sent a correct invoice to your customer. If this is the case, the factor checks the creditworthiness and liquidity of the customer in the next step. Because he wants to be sure that he will get his money after buying the debt. Only when the exams have been completed and the result is positive will he conclude a contract with you.
Step 4: Sale of Receivables
As soon as it is clear that everything is in order with the claim itself and with the creditworthiness of the customer, you can discuss the contract with the factor. It is important to precisely define all framework conditions for the sale. For example, you have to regulate in the contract which claims are involved, how long the term should be and what fees and interest apply.
Step 5: Transfer of the gross claim
Once the contract is signed, it takes about 48 hours for the factor to transfer 80 to 90 percent of the gross amount to you. In return, the purchase contract transfers your claim to the customer to the factor. He is now responsible for collecting the full amount outstanding and transferring the rest to you. According to the contract, he is 100% liable for the risk of default.
Step 6: The factor collects the outstanding claim
You no longer have to be active in this case. Because the factor writes to your customer (the debtor) and informs him to which (new) bank account he has to pay the outstanding amounts. He points out that this is a factoring process.
Step 7: The customer pays his debts
Normally, the customer pays the open invoice to the factor. If not, the factor bears the default risk.
Step 8: The factor transfers the remaining amount to you
In the last step, the factor transfers you the remaining amount of 10 or 20 percent and the process is ended.
