What is factoring and why choose it to finance your company?

For companies, liquidity is essential in their daily operation and therefore, they are always open to finding new mechanisms that allow them to increase it. An alternative that can help them increase the liquidity that companies require is a short-term financing system called factoring.

Through this system, a financial entity advances to the company the collections of outstanding debts, which also frees the company from the collection of its invoices. The advance collection of the amount of the debts is, without a doubt, an incentive for companies to increase their liquidity.

This option of financing short-term working capital, includes valuable additional services such as business advice and data on the creditworthiness of your clients. This financing alternative is gaining ground in Spain, where in 2016, the total amount of debt assignments was almost 68,000 million euros.

What is factoring?

For this financing system to exist, you need: a company with credit debts and a financial institution with whom to exchange debts for working capital. That is, a company or assignor, you agree to transfer your invoices in favor of a financial institution or factor, so that this factor can collect the invoices when they are due.

On the other hand, the factor advances the deferred money at a discount, which corresponds to the interest rate plus the agreed commissions. To have this system, a contract is made in which the risk involved in these financial operations is taken into account, because the factor is responsible for charging.

Assessing the risk of each operation is determined through the solvency of the assigned clients and those responsible for paying the invoices.

Types of factoring

With notification

As the transferor company authorizes the factor to collect its invoices, it is obliged to notify such decision to the clients involved, who are now obliged to pay the factor.

It should be noted that this transfer of invoices does not require any consent of the debtors, to be carried out. You only have to inform the debtors, to whom they must pay now, the debts they had with the transferor company.

For this, they are notified of the transfer of the rights of the debts contracted to the financial institution or factor, for that reason it is known as factoring with notification.

Without notice

When the debtor is not informed, he cannot know of the assignment contract, so he would continue to be legally obliged to pay the transferor company. And as he usually did, the debtor will pay his invoices to the transferor company, which can bring all kinds of inconveniences and risks.

Well, the debtor can argue changes to the conditions in which the services were contracted or the products were purchased, which gave rise to the debts. As there is no notification to the debtors, this modality is known as factoring without notification.

To cover the risks of this modality, there are two alternatives:

No recourse

The financial institution or factor assumes the risks of collection management, which implies greater investigation and evaluation of the debtors and a higher cost of the service.

Among the drawbacks of non-recourse factoring there is the non-payment due to commercial differences between the transferor company and the debtor, due to non-compliance with the merchandise, among others. In other words, the factor assumes the risk of default by the debtor.

With recourse

At recourse factoring, the transferor company assumes the risk of insolvency of its debtors, for which it must respond for the non-compliance in the payment of its clients.

If at the expiration of the invoices, the factor fails to collect the assigned debts, it can demand payment from the transferor company.

Advantages of factoring

Some factoring advantages and that lead to choosing it to finance your company are the following:

  • It increases the financing capacity of the company, since it obtains cash quickly and easily.
  • Cash flow improves, so the company will have a greater capacity to meet its commitments.
  • It improves the management of current assets, reducing the debt ratio.
  • It favors the management of the client portfolio and billing, helping to make better business decisions.

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