Factoring contract: what is it and how does it work?

Factoring contract: definition

The factoring contract is a type of contract under which a company transfers its invoices to a specialized company in exchange for early payment. . In other words, the company sells its invoices to a specialized company called a factor.

The factor advances payment of invoices to the company and then is in charge of customer collections. To cover itself against any unpaid invoices, it deducts a certain percentage from the invoice amount for set up a guarantee fund .

Factoring is a short-term financing method that enables a company to obtain early payment of customer invoices . This eliminates the need to wait for due dates to obtain the corresponding funds.

It is important to know that factoring is a technique reserved exclusively for B2B relationships.

How does the factoring contract work?

There are different types of factoring contracts:

• Partial factoring ;

• Classic factoring ;

• Online factoring ;

• Confidential factoring ;

• Etc.

However, the operating mode remains virtually the same.

Here's how a factoring contract works, in six steps:

1. The company provides the factor with a list of its customers . Depending on the type of factoring contract, all or some of the company's customers may be covered.

2. The factor analyzes the customer's financial situation and ensures their solvency;

3. The company receives orders and issues customer invoices ;

4. The company transmits its customer invoices as and when they are issued. ;

5. The factor pays the sum corresponding to the amount of invoices deducted from commissions and holdbacks to the company within an average of 24 hours;

6. The factor collects customer payments on their due date and manages any unpaid bills.

Depending on the type of factoring, the company must notify customers of the transfer of their invoices to a factoring company. This notification is made by placing a subrogation notice on the invoices sent to the customer.

Example of a factoring contract

Here's a concrete example to help you better understand the principle of factoring.

Company X has three main customers: companies A, B and C. It provides regular services with these corporate customers. However, payment is made after 35 days. Company X is growing fast and needs cash to invest and pay its employees.

This is how the CFO of company X offers factoring to obtain immediate liquidity. The company's sales department then set about finding a factor. A factoring contract was signed between the two entities.

The process begins when the company's invoices are sent to the factor. The factor then verifies and validates them. pays 80% of assigned invoices within 24 hours. The remaining 20% is deducted as a commission to remunerate the factor's services and to set up a guarantee fund.for the duration of the collaboration, the factor also manages the company's accounts receivable. It then takes charge of :

• Dunning ;

• Debt collection ;

• Litigation management in the event of non-payment ;

• Etc.

When the various invoices fall due, the company's customers pay the amount owed to the factor. Failing this, the factor recovers the amount of unpaid invoices in the guarantee fund.

At the end of the factoring contract, the guarantee fund is returned to company X.

Why use a factoring contract?

There's a common misconception, which is increasingly being challenged, that factoring is only for companies in financial difficulty. Admittedly, this technique makes it possible to immediate liquidity in the event of a significant gap between the company's cash receipts and disbursements . Factoring enables you to finance your working capital so that you can operate without waiting for your invoices to fall due.

However, on the other hand, factoring is a real alternative to bank loans, as it enables you to immediate liquidity without debt . It's a good way for any company to finance its working capital without too much risk. And it does so, even if it is not in financial difficulty per se .

There are a number of reasons why factoring can be used:

• If you need funds to invest ;

• To finance your working capital in off-peak periods when your business is highly seasonal;

• To support business growth ;

• To delegate customer account management tasks to save time and concentrate on your core business;

• To diversify sources of financing and avoid dependence on bank loans, for example.

What are the advantages of factoring?

Factoring is a financing solution that offers a range of advantages to companies:

Delegating debt collection

Factoring results in transfer the burden of administrative debt collection to the factor . In this way, the company avoids a task that can be both costly and unproductive.

Moreover, factoring involves more than just debt financing. The factoring company also performs additional tasks, such as the administrative management of customer accounts. For example, it handles customer reminders as well as litigation in the event of non-payment.

Immediate liquidity

In the normal course of business, customers are granted deadlines for payment of their receivables. The average payment term is 15 days . The legal deadline is 30 days. As a result, when invoices are issued, companies have to wait between 15 and 30 days on average (and even 60 days at the most) before being paid. From shifts can therefore arise in the cash position between cash outflows and inflows. This means that before payment deadlines, the company may feel the need for liquidity.

Factoring is the ideal solution in this situation. All the company needs to do is transfer customer invoices to a factoring company for immediate cash flow . On average between 48 and 72 hours for the factor to advance the funds .

Protection against non-payment

Once you assign your invoices to a factoring company, you transfer the risk of non-payment to him. In fact, from now on, it's this one that will take charge of collections On the other hand, it does require the creation of a guarantee fund to cover any outstanding payments. So, if a customer becomes insolvent, the company can simply draw on these funds to recover the cash advance it has paid.

And the drawbacks?

Factoring also has three major drawbacks:

A costly solution

The factor charges two types of commission:

• Financing commission. This is intended to remunerate the factor for the cash advance it has paid. It is an interest rate of between 2% and 4% of the amount of sales transferred.

• Factoring commission . This is the commission intended to remunerate the factor for the additional services it provides, including receivables management and credit insurance. It amounts to between 0.2 and 2% of the amount of invoices assigned .

In addition to these commissions, ancillary costs can also be applied to one-off operations and services such as litigation procedures, audits, etc. In addition holdback deducted by the factor.

All these elements are deducted by the factor from the amount of invoices assigned by the company. As a result, the company between 70% and 90% of their amount .

So it's essential to consider these costs and the potential impact on your cash flow before opting for factoring. In particular, you need to assess whether the solution remains profitable for your company, despite its costs.

A long-term commitment

Some factoring contracts require a long-term commitment (over several months, for example). Other types of contract may also require a "contract of sale". minimum sales threshold . Failure to reach this threshold may result in financial penalties.

It is therefore important to understand and negotiate the content of the factoring contract before signing. You also need to take the time to choose your factor carefully, to ensure that the solution brings real benefits to your business.

Deteriorating customer relations

The factoring contract entails partial divestment of customer relationship management . As a result, the company loses control over how it addresses its customers. It's also difficult to ensure that customer communications remain in line with company policy.

The factor could, for example, use more rigid covering methods. This contributes to the deterioration in the company's relationship with its customers . On the other hand, they may wonder about the company's potential financial difficulties.

What's the alternative to a factoring contract?

As we have seen, despite its many advantages, factoring also has a number of drawbacks. limites . Looking for an alternative to factoring? Consider Hero .

Hero est a payment solution reserved for B2B SMEs/SMBs . It offers an innovative alternative to factoring. With Hero, you can obtain advance payment of your customer invoices within 24 hours after transmission/validation by the platform.

The platform also offers payment facilities such as deferred payment and payment in instalments . This means you can pay your suppliers in 3 or 4 instalments, or deferred payment, while the platform advances payment. The process works both ways, since you can also offer these payment facilities to your customers. However, no risk to your cash flow because the platform pays you an advance on your invoices.

At the same time, there's no damage to your business relationships, since the platform works without notifying your trading partners.

Taking out a factoring contract offers many advantages to companies seeking immediate liquidity to finance their business. BFR.Il is not without its drawbacks, however, given its high cost. Hero thus emerges as a more flexible and less costly alternative to factoring contract .

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• Online factoring: finance your invoices online with Hero

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