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What is factoring and how does it work?

What is factoring and how does it work?

Temps de lecture : 4 minutes

Factoring is an alternative financing solution for companies, enabling them to obtain advance payment of their trade receivables. It's the English version of factoring. What does factoring involve? What are its advantages and disadvantages? We tell you more in this article.

Factoring: definition

Le factoring, ou affacturage in French, is a process that makes funds available for customer invoices without waiting for their due date . To do this, the invoices are assigned to a specialized company called a factor, which advances the payment.

In other words, factoring is a short-term financing solution which allows a company obtain liquidity without incurring debt . It is therefore an alternative to bank loans. Factoring is not a loan. The factor is not reimbursed by the company. It is reimbursed in collecting payment directly of customers on the due date.

He is in charge of cover once the invoices are overdue. At the same time, he deducts a reserve from the amount of the assigned invoices to build up a guarantee fund. This enables him to protect yourself against unpaid bills .

Depending on the type of factoring, the company may be required to transfer all or only part of its customer invoices to the factor.

In addition to invoice financing, factoring contracts cover a range of other services:

  • Receivables monitoring ;

  • Customer reminders ;

  • Client workstation management ;

  • Guarantee against non-payment.

Who can benefit from factoring?

Factoring is primarily aimed at to B2B players . This means that any individual or legal entity whose customers are private individuals (B2C) cannot access this process.

Factoring is also suitable for all business sectors . When it first appeared, factoring was intended for large companies. In recent years, however, it has become increasingly popular with medium-sized companies such as VSEs and SMEs.

Furthermore, factoring can be adapted to different stages of a company's operations and to different contexts:

  • In the creation phase This is the phase when start-ups and young companies have little equity capital. Factoring provides them with the funds they need to operate without having to wait for payment deadlines.

  • In times of strong growth Factoring gives companies the liquidity they need to finance their growth.

  • In the investment phase Factoring provides the funds needed to finance the purchase of equipment or the hiring of employees, without jeopardizing cash flow.

Finally, factoring is only possible for invoices that are certain, liquid and due . On the other hand, this financial technique is not suitable for invoices relating to down-payments or maintenance services.

Why factor?

Le factoring enables a company to optimize its cash flow. In the normal operation of a company, it takes between 30 and 60 days to receive payment from its customers. In the meantime, it may need cash to pay employees, buy equipment or invest. Transferring your trade receivables to a factoring company is therefore a good way of obtaining the necessary funds without having to go into debt.

Factoring can be an interesting solution in one of the following practical cases:

  • In the event of a temporary need for cash ;

  • To diversify its sources of financing. Factoring is particularly interesting for small businesses that have difficulty obtaining bank loans.

  • To finance investments.

Moreover, as we have seen, factoring encompasses other services, notably receivables management. It is therefore a solution for outsourced accounts receivable management to boost productivity.

How does factoring work?

The first step is for the company to choose a factor based on its reputation and sector of activity. For its part, before accepting a company's invoices factor analyzes its customer portfolio In case of validation by the factor, a factoring contract is concluded . The company must inform its customers of the existence of a factoring contract.

Here's how a factoring contract works, step by step:

  • You receive orders from your customers;

  • Ask your factoring company about the amount of the guarantee. offered for the customer in question. This may be subject to negotiation.

  • You fill the order Delivery or service to the customer ;

  • You draw up an invoice mentioning subrogation to inform the customer that he must pay directly to the factor. This formality of notifying the company's customer is not necessary in the case of confidential factoring. This type of factoring is specifically designed not to reveal the existence of the factoring contract to customers.

  • You send the invoice at factor as they are issued, specifying the payment terms ;

  • In exchange for this transfer of invoice, the factor advances you up to 90% of the assigned invoice amount. He deducts his commissions and holdbacks.

  • On the due date, the customer pays the invoice directly to the factor .

The advantages of factoring

Factoring offers a number of advantages:

  • Outsourcing accounts receivable management . Factoring saves time and increases productivity, as staff can be assigned to higher value-added tasks.

  • Transfer the risk of non-payment to the factor . Once the invoices have been transferred to the factor, the risk of non-payment is also transferred to the factor. Factoring includes a credit insurance component. In the event of non-payment, the factor is covered by insurance or via the guarantee fund it has set up.

  • Immediate liquidity . Under normal circumstances, a company must wait a certain amount of time before collecting its receivables. The legal deadline ranges from 30 to 60 days. In the meantime, they may find themselves short of cash. Factoring is one way to remedy this situation, and to finance your business. BFR .

  • An alternative to bank loans . Startups or TPE / PME may find it difficult to obtain credit. Factoring is therefore an alternative way of obtaining funds when needed.

  • A solution to avoid the harmful effects of late payment.

  • A solution that improves DSO (average payment period) and avoid bank overdrafts and agios.

What are the disadvantages of factoring?

Factoring also has its drawbacks:

  • The factor may require a minimum sales figure failing which penalties will apply. So be sure to read the contract carefully before opting for factoring. You also need to weigh up the potential benefits and risks.

  • A costly process . Factors base their commission on the level of risk they take. The riskier your customers appear to be, and the more likely they are to fall into arrears, the higher the factor's commission will be.

  • Rigorous selection criteria. Before accepting a company as a member, the factor takes care to analyze its situation. This rigorous selection process means that not all companies are eligible for factoring.

How much does factoring cost?

Factoring combines different services: invoice financing and customer management. The cost of factoring thus encompasses various elements:

  • Factoring commission . It is used to remunerate the factor for accounts receivable management. It amounts to between 0.2% and 2% of assigned sales.

  • The financing commission . Its purpose is to remunerate the factor for the cash advance it provides. It is calculated on the basis of 3-month Euribor, and depends on the amount and duration of the factoring contract. It amounts to around 4% of the amount of invoices transferred.

  • Additional costs . These are charges for exceptional or non-recurring services rendered by the factor. These are :

    • Application fee ;

    • Overriding financing costs ;

    • Audit fees ;

    • Customer notification fees ;

    • Etc.

When talking about the cost of factoring, it is essential to mention guarantee funds . This is a deduction made by factors on the amount of invoices assigned to cover themselves in the event of non-payment.

Hero: an alternative to factoring for boosting cash flow

Hero is a payment and une alternative less expensive and more practical that factoring In fact, it allows obtain payment of customer receivables within 24 hours of their issue. It's a solution specifically designed for PME/TPE B2B and therefore fully adapted to their needs.

Request a customized quote

Hero also offers two types of payment facility: deferred payment and payment in instalments So you can offer your customers the option of deferred payment (after 30 to 60 days) or payment in 3 or 4 instalments. And you don't have to worry about any adverse effects on your cash flow. In fact, the platform advances you the invoice amount the very next day.

You can also take advantage of the same payment terms when dealing with your suppliers. In other words, pay your supplier invoices in instalments or on a deferred basis without fear of offending your business relations. The platform also advances your payments to your suppliers.

In conclusion, factoring is a payment solution that enables a company to benefit from immediate liquidity in case of need. However, like banks, factoring companies set stringent conditions for access. Solution for factoring Hero is a modern, digitized solution that democratizes access to this financial technique.

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Écrit par

Valentin Orru

Head of growth