How can it help me?
Factoring can improve your cash flow by giving you quick access to working capital. If the arrangement is ‘without recourse’ (see below), it can also reduce significantly your risk of non-payment.
What is it?
Factoring is selling your book of debts (or ‘accounts receivable’) on an ongoing basis to a factor—a bank or a specialised factoring firm. The factor then manages your accounts receivable ledger (or ‘debtors’) and collects your debts.
Factoring is particularly suited to short-term export sales with payment periods of up to 180 days.
How does it work?
The main steps in a typical export factoring arrangement are:
- You and a factor enter into an agreement to sell your export debtor book to the factor for a fee. Before this, the factor will often investigate the credit standing of your buyers and may set credit limits for your buyers.
- When you ship goods to a buyer, you provide the payment invoices to the factor.
- The factor pays you up to 90 per cent of the invoice value, usually in cash and within two days.
- The factor then undertakes your accounts receivable and credit management activities on the terms agreed with you, using their international network to collect payment from your buyers.
- The factor pays you the balance of the invoice value either after a set period or after they collect the debt.
Factoring agreements may be:
- with notification—all parties, including your buyers, are aware that the debt has been sold to the factor
- confidential—only you and the factor know of your agreement
- with recourse—the factor assumes responsibility for your credit management, but if a buyer fails to pay then you have to repay the factor the money they advance to you
- without recourse—the factor provides you with full credit cover against all debts they accept. The factor will usually wish to set an agreed credit limit for each of your debtors and will charge a higher premium to accept debts on a without recourse basis.
A factor generally requests access to purchase a certain proportion of your sales volume over a particular period.
Factoring is different to invoice discounting, in which you also receive upfront cash for invoices but retain the credit management and collection functions. The fee structure for factoring and invoice discounting facilities may also differ.
The diagram below shows the main steps in a typical export factoring arrangement.
Notes to diagram
- You enter into an export contract with your overseas buyer.
- You agree to sell your export debtor book to a factor. The agreement will usually require payment of a service fee and interest to the factor.
- You provide goods or services to your buyer in accordance with the export contract.
- You send your buyer an invoice for the goods or services.
- You forward a copy of the invoice to the factor.
- The factor pays you the agreed percentage of the invoice value.
- The factor collects the invoiced amount from the buyer (if the factoring is not conducted on a confidential basis).
- The factor pays you the balance of the invoice value.
What are the pros and cons?
| Pros |
Cons |
| Improves your cash flow and gives you access to working capital |
If your factoring agreement is with recourse, you still carry the risk of non-payment |
| If the factoring agreement is without recourse, it significantly reduces your risk of non-payment—as long as you fulfil your obligations under the export contract |
Without recourse factoring is a more costly means of protecting yourself against buyer non-payment than export credit insurance |
| Provides a flexible form of finance, as the funds available increase with the total value of your invoices |
Often unavailable for export sales to markets with high buyer and country risks (for example, developing markets) |
| Can give you the option of providing credit terms to your customers and make you more competitive in international markets |
Fees and charges may reduce the total profit margin of your export contract |
| Can free up your time and resources by outsourcing your accounts receivable and credit management |
If export sales are in a foreign currency, a higher premium may be payable to reflect the factor’s exchange rate risk |
| A factor uses their established network to collect debts quickly and efficiently and may be able to provide advice on the creditworthiness of your current or prospective debtors |
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| If your export sales are in a foreign currency, factoring may reduce the length of your exposure to exchange rate risk by bringing forward your effective payment date |
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What costs are involved?
A factor usually charges a service fee and interest on the funds advanced to you. The cost depends on the time frames in which you sell your invoices to the factor, the amount of the advances you receive and the factor’s assessment of buyer, country and exchange rate risk. A factor will charge a higher premium to accept debts on a without recourse basis.
If the factor provides credit assessment services, additional fees and charges may be payable.
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