What Is a Factor, Exactly?

In this latest article from FCI Member, MNS Credit Management Group, they explain what a factor is and how modernisation using factoring can increase working capital.

What Is a Factor, Exactly?

A factor is a financial intermediary who buys a company's receivables and offers cash or credit. A factor is essentially a funding source that commits to paying a corporation the invoice amount less a commission and fee discount. Factoring can assist businesses with their short-term financial needs by selling receivables in exchange for a cash injection from the factoring provider. Factoring, factoring finance, and accounts receivable financing are all terms used interchangeably to describe the process. Unlike Banks that finance a receivable on the basis of securities (both primary and collateral securities), a Factor provides finance without security and where it is a non-recourse factoring, the factor assumes the credit risks involved in the transaction.

A Step Forward in Modernization using Factoring

Factoring has a 4,000-year history. Almost every civilization that valued trade used some type of factoring, including the Romans, who were the first to sell promissory notes at a discount. Prior to the revolution, the American colonies were the first to apply factoring in a large-scale, documented way.

Factoring became more focused on credit issues with the introduction of the industrial revolution, but the essential idea remained the same. Factors could genuinely guarantee payments for qualified consumers by supporting clients in analyzing their customer's creditworthiness and establishing credit limits. Factoring was predominantly used in the textile and garment sectors in the United States prior to the 1930s, as these businesses were direct offspring of the colonial economy, which specialized in factoring.

Factoring is becoming more significant in today's industry as time passes and we move into the modern era of rapid communication and a decentralized world. The rising interest rates in the 1980s and 1990s prompted a surge in the number of new businesses entering the factoring industry. Factoring is a type of "off the balance sheet" financing that allows businesses to quickly raise funds. Factoring is a means to raise rapid cash without creating a loan liability because accounts receivables are asset accounts.

People frequently feel that factoring is a lender of last option, but this is not the case because exporters seeking factoring are typically in the early stages of expansion. Factoring appears to be costly at first glance, but it actually accomplishes a lot more; in effect, it replaces the accounts receivables and credit departments.

Advantages

• Factoring assists in converting receivables into cash quickly - Reduces DSO.
• Increases Debt Capacity.
• It provides credit protection for receivables
• It enables a firm to meet rising sales demand and expand
• Factoring saves time because the invoice finance company collects the funds.

Downsides

• The most significant downside is that the cost of a factoring arrangement may be higher than the cost of other alternative financing options which means a reduction in profit margin.
• Another downside of factoring is that it can harm client relationships, particularly if the factor uses aggressive or unethical collection techniques.
• Some customers may prefer to deal directly with you.
• It may?reduce the scope for other borrowings?- book debts will not be available as security.
• Factors may go selective on debtors or poor debtor spread who need to be managed directly by Creditor.

What is the mechanism behind it?

The picture above depicts the factoring model and how it is carried out.

1. First, the importer contacts the exporter to make an order.
2. Second, the exporter informs the factor of the transaction's information.
3. Finally, the exporter delivers the items to the importer and submits an invoice in time for the factor to be paid on time.
4. The exporter sends a copy of the invoice to the factor.
5. The exporter receives the money from the factor.
6. The customer pays the factor on the due day.
7. The client receives the balance from Factor.

About our Member MNS Credit Management Group

• Visit their website here.??????????????????????
• Article Reference: here.

Discover more by FCI

• Explore the online course by the FCI Academy "Fundamentals on Domestic and International Factoring Course" here.
• Explore publications on Factoring and Receivables Finance, sorted by countries and regions?here.