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An introduction to Factoring and Commercial Finance

Factoring Basics

Factoring is a long-established way of providing a range of business support services:

  • Working Capital (Finance)
  • Credit Assessment of customers/ buyers
  • Sales Ledger Management and Collection
  • Credit Cover 

Across Europe, where it is well established, the Industry represents 10% of GDP; globally the figure is around 3.5% and rising. That’s €1.5Trillion of client user turnover in Europe, €2.4Trillion in the world.

The Industry in Europe has grown from €845Bn in 2008 to its current level; this growth confirms the important role played by the factoring industry in sustaining liquidity supply to businesses, particularly through a period of financial crisis.

At the end of 2016, around 200 providers were supporting 180,000 business users and providing them with €200Bn of funding. Of these users, nearly 90% are Small and Medium sized Enterprises.

Factoring can provide higher levels of finance to the user with fewer conditions than comparable traditional methods of funding. In other words, factoring helps EU Industry to enhance its financial competitiveness, an essential element in allowing it to thrive and compete in domestic, the single and in international markets.

Not only that, it also is a low loss given default solution. The EUF’s 2015 Whitepaper showed it to be around four times safer for the financial institution than traditional lending.

That’s why the Industry calls it win: win finance!

EU Factoring growth since 2007 (in thousands of euros)

How does it work?

Factoring and Commercial Finance companies (the Factors) work with client businesses to provide finance to enable them to trade. These Factors offer businesses (the Sellers) the funding they need to meet day-to-day business expenses, including payments to suppliers, salaries, rent and rates. This funding is known as “working capital”. The amount of funding that a factor can provide is contingent on the volume of sales the Seller generates; it may be sufficient to meet the needs of the Seller on its own or may be complementary to that raised from traditional sources.

Factoring and Commercial Finance is based on the idea of selling / assigning a business’s unpaid receivables (sales invoices) to the Factor for a payment equivalent to the value of the invoices less a fee for offering the service and a charge for the period the invoice is financed. This means that instead of having to wait 30 or 60 days, or even longer for payment from their customers (the Buyers), the Seller can have access to their funds usually within 24 hours and often sooner. The Factor will then collect the invoice payment from the Buyer and recover their advance.

The Factor can also offer additional services to the Seller. They will offer assessments of the creditworthiness of the Buyers that the Seller is selling to. This service will be available to the Seller both on existing and potential Buyers and is a constant review service, helping the Seller to make informed real time decisions about offering credit. 

The Factor can include Sales Ledger Management and Collection services. These may be fully outsourced to the Factor or may be kept in house by the Seller depending on the product offered. 

For an SME, the opportunity to outsource its collection activity and manage the ledgers can be a very valuable benefit. For larger companies with developed and dedicated accounts departments, the collection and ledger monitoring and management activity can more easily be kept in house. 

The Factor can offer Credit Cover, a type of buyer default protection which can give the Seller greater confidence in selling in volume to its buyers, also in a cross border context. Because of economies of scale, the cost of such credit cover is usually much less via the Factor than it would be for the Seller to obtain on a stand-alone basis.

Which version of the factoring offer is used depends on the detailed circumstances of the Seller, its Buyers and the local market.

Regardless of the specific form factoring takes, it will always be a Secured and a Monitored form of financing. Secured because the Receivables are assigned to the Factor and payments from the buyers have to be made directly to the Factor, even in the case of the seller’s insolvency. Monitored, because the Factor will permanently follow up on the details of the receivables portfolio it is financing.