Sufficient liquidity at all times is essential for smooth business operations. In many cases, this poses a particular challenge, especially for small and medium-sized companies, but also for start-ups.
If customers are grant generous payment terms for reasons of competition, this can lead to restrictions in the availability of free financial resources. As a result, business decisions that may be necessary cannot be made in the desire form. In order to avoid these negative effects on business operations, it is necessary to be able to flexibly adjust the credit line to current circumstances as quickly as possible. However, banks often react too slowly when applying for an extension of an existing overdraft facility, since this process is usually associated with a complex application process.
The factoring principle
This is different with factoring. With this financing tool, it is possible for companies to structure their financial scope flexibly and, if necessary, to expand it quickly and without great effort.
Basically, factoring is about converting customer invoices with payment terms into liquid funds more quickly. To do this, a so-called factor buys the claim. Immediately after the transfer of the claim to the factoring provider, the latter transfers a large part (approx. 90 percent) of the outstanding invoice amount to the company that issue the invoice – the remaining amount minus factoring fees is pay out as soon as the customer has pay the invoice in full .
However, the uncomplicated and rapid increase in liquidity is not the only advantage of this financing model, which originally came from the USA. With “genuine factoring”, which is common in Germany, the default risk is also transfer to the factor when the receivable is purchase. The factor also takes over the entire receivables management and thus significantly relieves the administration of the billing company.
Factoring in practice
If a company provides a service, the customer receives an invoice for it, which is link to a future payment term. It may take several weeks or even months for the invoice to be settle. During this time, the delivery company’s liquidity is reduce by the amount of the invoice. The sum of all open invoices can add up to significant amounts that can have a negative impact on the company’s balance sheet.
In such a situation, factoring offers the opportunity to take targeted countermeasures. For this purpose, a so-called factoring contract is concludwith a factoring company. This defines a financial framework within which receivables can be purchase. He also regulates the factoring fees incurred.
Immediate payment after invoicing
After the invoice has been created and assigned to the factor, the factor usually transfers around 90 percent of the invoice amount to the invoice issuer within 48 hours. The remaining amount is credit to the company by the factor after the customer has pay the invoice in full (direct payment to the factor). If the customer becomes insolvent and unable to pay in the meantime, the resulting financial damage remains with the factor. In close coordination with the customer, the factor also takes over the entire receivables management including the dunning process.