All you need to know about factoring: definition, advantages, how it works

Are you looking for a financing solution for your business? factoring ? This is a financing method that enables companies to dispose of their trade receivables without waiting for their due dates. With 174.2 billion euros of invoices handled in 2021, factoring remains the leading short-term financing method for companies in France.

In this article, we tell you everything you need to know on the subject.

What is factoring?

Factoring is a financing solution that enables companies to obtain early payment of trade receivables ahead of schedule Factoring, a term introduced in France in November 1973, is also defined by the Larousse dictionary as "the factoring of goods or services. transfer of trade receivables from a company to a financial institution which, for a fee, takes charge of their collection and bears the risk of non-payment".

It is carried out within the framework of a contract signed with a specialized financial organization known as a factor.

In practice, the company transfers its invoices to the factor, who is then responsible for managing the company's accounts receivable. In particular, the factor handles dunning and collection operations.

Generally speaking, the factor offers 3 types of service:

• Financing assigned invoices This enables companies to optimize their working capital requirements;

• Cash management ;

• The guarantee against non-payment . Also known as credit insurance, this service involves intervention in the event of non-payment by a company's customer.

Factoring is only available for B2B invoicing. It cannot be used to finance invoices issued to private individuals. In addition, the invoices concerned must be certain, liquid and due.

You should also be aware that factoring is not possible for certain types of invoices, such as those for maintenance services or requests for advance payments.

Factoring differs from a loan in that the company does not have to reimburse the factor . The latter is reimbursed directly by the company's customer.

How does factoring work?

The factoring mechanism works in 4 stages:

• Le factor analyzes the company's financial situation on the basis of information provided by the latter. In particular, he studies accounts receivable, customer profiles and creditworthiness, and outstanding invoices. This step enables him to assess the risks he will have to face.

• If the company's situation is favorable, a factoring contract is signed between the two parties. This sets out the terms and conditions of the factoring:

  • Salary conditions ;

  • Free access to company accounts;

  • Performance bond terms and conditions ;

  • The amount of the guarantee fund ;

  • Etc.

• Once the contract has been signed, as and when they are issued, all invoices and payment deadlines are forwarded to the factor . It is important to know that these shipments can be dematerialized.

• The factor advances the amount of each invoice deducting costs and any holdbacks.

• The factor collects payment for receivables after due date and initiates the necessary recovery operations in the event of unpaid invoices.

What type of company is it for?

In the past, factoring was reserved for large accounts. In recent years, however, factors have increasingly adapted their offer to small and medium-sized businesses. The latter are generally looking for simple, fast and flexible solutions.

In addition, factoring is only available to to B2B companies . In other words, it is only suitable for companies that invoice other companies.

In addition, factoring caters to a wide range of company profiles:

• Fast-growing companies ;

• Small businesses that wish to finance their investments;

• The companies that grant long payment terms s to their customers;

• The ones that want to optimize their DSO (average customer payment time) ;

• The ones that wish to delegate the management of their accounts receivable without the need for cash advances;

• Those that are highly seasonal .

When does a company need factoring?

Factoring is a financing solution that helps companies improve their cash flow. It avoids the need to wait for due dates to collect receivables.

Here are some concrete situations in the life of a company where factoring may be appropriate:

• In the case of a punctual need for liquidity ;

• For finance investments ;

• For outsource accounts receivable management ;

• For diversify your sources of financing .

How does factoring pay for itself?

The factor is remunerated through two mechanisms:

• It applies an interest rate on the amount of invoices assigned to remunerate it for the cash advance it has made. This is based on 3-month Euribor.

• It also samples a factoring commission . This is intended to remunerate the company's customer management costs and its collection services for assigned receivables.

From additional expenses can also be added:

• Application fee ;

• Minimum charge per invoice ;

• Audit fees ;

• Litigation costs ;

• The cost of participating in a guarantee fund to cover the risk of non-payment... Thanks to this guarantee fund, the factor can fully guarantee payment of receivables. This fund is returned to the factor at the end of the contract or in the event of contract termination.

Factors can also offer small and medium-sized businesses flat-rate pricing based on a predetermined number of invoices.

How much does factoring cost?

Given the factor's remuneration method, the cost of factoring comprises :

• Management costs . This varies between 0.1 and 3% of capital based on the customer's level of creditworthiness, the size of the company and the amount of sales of invoices assigned to the factor.

• Invoice financing commission . It is set according to a percentage applied to the invoice amount. The amount of the percentage is based on the 3-month Euribor, i.e. between 0.2 and 3 based on the volume of receivables sold.

• The amount of the contribution to the guarantee fund in the event of non-payment. This is set in proportion to the outstanding customer balance.

• Application fees, if any . Factors do not systematically apply these fees. Their amount can be negotiated when the factoring contract is signed.

What are the advantages of factoring?

Factoring offers a number of advantages for companies:

• Benefit from a financing tool t, an alternative to bank loans. Factoring offers a real opportunity for VSE/SMEs and start-ups to finance their working capital requirements, since a company with little equity capital may find it difficult to obtain a bank loan. Especially as banks increasingly limit short-term financing solutions . Factoring is therefore an alternative way of financing cash flow without waiting for receivables to fall due.

• Delegate customer receivables management . Factoring enables you to outsource the management of your accounts receivable to a third party. Managing customer relations, unpaid invoices, collections and any disputes is a process that requires time and expertise. Outsourcing them allows you to concentrate your team's efforts on higher value-added tasks.

• Get to know your customers better . By entrusting the management of your accounts receivable to a specialized organization, you can benefit from better customer sourcing. As a result, you'll be able to optimize your payment times and anticipate potential disputes.

• Protect yourself against the risk of non-payment . Paying commissions and management fees is preferable to incurring legal collection costs, for example.

• Improve your DSO or average credit period. This allows you to avoid agios and the cost of bank overdrafts.

• Avoid the negative effects of late payment .

What are the disadvantages?

Factoring also has certain disadvantages:

• The factor generally requires a minimum invoice amount ;

• The amount of receivables are not recovered in full since the factor charges fees and guarantees. As a result, this technique should be used sparingly.

• Careful selection of companies who can benefit from factoring. Factors are generally very selective when it comes to selecting their members, given the risks they take. Companies with a large number of subcontractors are generally excluded.

How do you set it up?

Are you convinced that your company is eligible for factoring? Would you like to do so? There are still a number of stages to go through before you can make your project a reality:

• Ensuring that factoring is the optimum financing solution for your situation . In view of the costs involved, it's worth taking the time to think it over.

• Check the amount of financing from which you can benefit. To find out, select your business customers and your outstanding invoices. Generally speaking, you can benefit from an average financing rate of up to 80%.

• Select factor . Just as when choosing a bank, you need to select the organization that offers you the best contract in terms of benefits and cost. Generally speaking, you can choose your usual bank or a non-bank factor. The latter may be a good option if you want to diversify your sources of financing. You can also choose a factor that specializes in your field of activity and can support you in your export activities.

• Time to install . This varies from 1 week to 1 month, depending on the terms of your contract. So it's important to take this into account, especially if you're in urgent need of cash.

What are the alternatives?

Aside from factoring, companies have a wide choice of financing options. But you need to know how to choose, based on your objectives, your needs and the advantages and disadvantages of each option.

Bank overdraft

It's the ideal solution for short-term cash requirements . Its main advantage is that it requires no complex procedures. It involves authorizing the bank to post a negative balance on the company's bank account.

Discounting

This type of financing involves a bank making a cash advance to a company in return for a commercial paper assigned by the company. Like factoring, this technique enables the company to collect its trade receivables without waiting for the due date. The main difference between these two mechanisms, however, lies in the delinquency management . The bank turns against the company to be reimbursed in the event of non-payment. With factoring, on the other hand, the factor itself assumes the risk of non-payment.

Dailly assignment

This is a financial process that enables a company to assign its receivables to a financial institution in return for interest payments . Like factoring, cession Dailly also enables a company to obtain a cash advance without waiting for its trade receivables to fall due, but it differs from factoring in that it requires authorization to be renewed each year, and is limited to a financing service.

The MCNE

Meaning "Mobilization of foreign debt", it refers to a dedicated financing method for export-oriented companies. The bank advances the amount of a receivable while awaiting payment from the foreign customer.

Hero, the payment solution for very small businesses

Hero is a payment solution equivalent to factoring . In fact, we offer instalments and deferred payment . In other words, you can offer your customers the option of paying later or paying in three or four instalments, but you must be careful not to overpay. the platform immediately advances payment of your invoices.

In conclusion, factoring is an attractive technique for companies, as it enables them to preserve their cash flow, but factoring companies are very selective when it comes to choosing their members. To benefit from a affacturage more flexible and adapted to small and medium-sized businesses, turn to Hero.