What is financial factoring?
Financial Factoring is a short-term financing mechanism that supports the growth of companies, it is a transaction derived from a contract through which a company sells its accounts receivable or invoices to a financial company in order to obtain the advance payment of credit sales made to its customers. This financial vehicle helps businesses gain liquidity after receiving cash faster than it would if it collected itself.
Advantages and disadvantages of financial factoring
Financial factoring is an excellent financial vehicle for short-term debt as it helps companies to solve the working capital that they have trapped in long payment terms agreed with their clients. For companies looking to improve cash flow, there is no shortage of options, the real challenge is finding an approach that doesn’t have a negative impact on the company’s bottom line.
Advantages of Factoring
- Immediate liquidity: Companies like factoro.mx have the ability to collect their invoices when they need to, effectively reducing the cash conversion cycle of their credit sales and this allows them to inject capital into their business and cover their company’s operating expenses on their terms.
- Cash Flow Optimization: Resource planning according to treasury requirements that improves the cash positions of companies.
- Collection risk reduction: Companies do not have to worry about collecting invoices with their customers, the factor is in charge of executing the collection on the due date of the invoices.
- It does not represent a bank liability: When factoring is without recourse, suppliers do not acquire a bank liability by assigning their credit rights to the factor.
- Flexibility to negotiate commercial terms: It is not necessary to reject business opportunities for long payment terms, introduce the effective cost of time in the commercial agreement with clients.
Disadvantages of Factoring
- Factoring has a financial cost: Financial factoring has a cost for the purchasing company or for the supplying company, this depends on the type of factoring contracted, the advance term in relation to the due date of the invoice and the interest rate. applied by the financial institution.
- The interest rate depends on the buyer’s credit risk : When the factoring company assumes the risk of collecting invoices, it is necessary to carry out an analysis to determine the purchasing company’s ability to pay.
What are the types of factoring?
Factoring by type of company
- Customer Factoring (Accounts Receivable Factoring): Also known as Traditional Factoring, it is used when a Seller generates a credit sale to a Buyer and issues a receivable invoice. The Seller assigns the credit rights to the factoring company, the Factor, to anticipate the resources, usually 80% of the value of the invoice. On the due date of the invoice, the factor collects the Buyer. Once payment is received by the Buyer, the Factor deducts the interest applicable to the agreed financing and deposits the remainder to the Seller.
- Supplier Factoring (Accounts Payable Factoring): Also known as “Confirming” and “Productive Chains”, it is the model where a Buyer pays its Suppliers in advance through a prompt payment program with a factoring company. Under this scheme, Suppliers can collect their invoices when they need it directly with the Factor without having to wait for the full term. At maturity, the buyer pays the face value of the invoice to the factoring company.
Factoring by type of resource
- Recourse Factoring: Makes up the majority of the accounts receivable financing industry. It is based on the agreement between the Seller and his Factor regarding the responsibility of the debt. In the event that the Factor is unable to collect the invoice from the Buyer, the Seller is responsible for covering the cost of said invoice to collect or return the funds advanced to the Factor.
- Factoring without Recourse: It is the opposite case, where the Factor accepts greater risk regarding the possibility of non-payment by the Buyer. In this scheme, the Factor anticipates the payment of the account receivable to the Seller and assumes the collection risk with the Buyer at the expiration of the Invoice. In cases of commercial disputes (eg, the buyer did not accept the product due to defects) the Seller must respond to the Factor for non-payment.
What is the cost of financial factoring?
The cost of financial factoring is based on the type of factoring, the financing term with respect to accounts receivable and the interest rate granted to the debtor. Factoring to suppliers is usually more.
Additionally, depending on who is requesting the factoring and which company has the bargaining power in the commercial terms of the sale, it is possible to collect the cost of financing in advance or at maturity.
- Advance Interest Payment: A discount is applied to the invoice for the advance term in relation to the due date and the financing rate. The cost of factoring is absorbed by the Seller when requesting the advance payment of its invoice.
- Interest Payment at Maturity: The Seller receives the full value of his invoice and the Buyer receives an extension in the payment term of his accounts payable. The cost of financing is absorbed by the Buyer when paying the invoices when they are due.