Main Types of Factoring

I.Full Service

Factoring in its full form, or traditional factoring, is a continuous relationship between a factor and the client (the supplier of goods and services to trade customers), in which the factor purchases substantially all the trade debts of his client, arising from such sales, in the normal course of doing business. This comprises all the factoring services, so that in return for the agreed fees and finance charges, the client receives:

  •       financing
  •       debt administration
  •       collection of debts due
  •       risk coverage, in case of non-payment of debt

This type of factoring is best suited for small and medium size companies, which have a swift development and they need not only financing, but also administrative support and risk coverage. It is also suited for large companies who target their exports to new markets.

The factor takes over the clients' debts, becoming solely debtor towards the client. The transfer of debts' ownership is normally accompanied by the submission to the factor of the copies of invoices that represent the debts sold. In some cases, the factor may require also the submission of the original invoices, to be able to forward them to the debtors, accompanied by copies of retention by the factor. The contract between the client and the factor is totally notified to the debtors. Many factors arrange nowadays for their large clients to notify them the debts by electronic means.

The factor is responsible towards the client for the purchase price of the debt assigned. The purchase price is normally the amount of any discount or other allowance granted to the debtor and, in some cases, after the deduction of the factor's charges. The factor will credit the client's account with the purchase price of debts sold and as a corollary the client may charge all his sales to the factor's account. The client will consequently look to the factor alone for the collection of the invoices.

The final date for payment of the purchase price will be either a fixed number of days after the invoice date (often referred to as the maturity date), or when collection has been effected from the debtor.

To the extent that the factor has given approval of the debts, the factor purchases them without recourse to the client. The client thus receives full protection against bad debts provided that they do not sell to any debtor that the factor did not agree with, or to an extent greater than the approval given by the factor (for debts approved and uncontested).

By making an early payment (prepayment or initial payment) on account of a substantial part of the purchase price, the factor provides the finance for the client to meet the debtors' trade credit requirements. Some factors make such payment by way of an advance secured by their right to set off against the full purchase price when due, whereas others provide for prepayments as part payments of the purchase price.

The factor will make a retention of part of the purchase price of each debt, so that in aggregate he will hold a sufficient balance to provide for any debt to be charged back to the client by way of recourse for the non-payment of an unapproved or disputed debt. However, the balance credited for the purchase price of debts purchased less the retention may normally be drawn by the client by way of prepayment at short notice.

II.Recourse factoring

A large number of the factoring companies do not offer complete factoring services, being specialised in recourse factoring. Although most forms of factoring other than the full service are provided with full recourse to the client in respect of the failure of the debtor to pay for any reason, recourse factoring normally describes the service by which the factor provides finance for the client and carries out the functions of sales ledger administration and collections, but does not protect the client against bad debt. The factor has „full recourse", meaning the right to have payment guaranteed or the debt repurchased by the client for debts unpaid for any reason, including the insolvency of the debtor.

Thus, the services the client receives are:

  •       Financing
  •       Sales ledger administration
  •       Collection of debts due

For every debt purchased by the factor, he will have the right to sell it (or part of it) back to the client for the amount for which he credited the purchase price originally, in addition to his charges (or be guaranteed in full by the client) to the extent that the debtor shall not have settled the debt by an agreed period after the invoice due date.

The period often agreed is 3 months or 90 days from the end of the month in which the invoice is dated. Such a period postulates that in many trades, in which it is common the payment to be due at the end of the month following the one of the invoice, the factor must collect payment within 2 months of the due date or the recourse may come into effect. It is usual to provide that the factor will refrain from exercising his right of recourse for a specified further period, in exchange of an additional charge paid by the client. In such case, the factor may require that an additional retention be maintained against the purchase price of further debts, so that in effect, the client will repay the amount paid by the factor against, or on account of the purchase price of the unpaid debts. In this way, in respect of debts that are seriously overdue, the client will remain relieved from the collection function, but the finance for such debts may be withdrawn. If it becomes irrecoverable, the recourse is then finally exercised.

Approvals of credit on debtors' accounts are given by the factor, for the purpose of specifying the amount of finance available against them or as an advisory service to the client, or for both reasons.

III.Invoice discounting

For the clients who need finance for the trade credit requirements of their debtors, but no administrative service or risk coverage, another service is extensively provided by the factoring companies.

Factoring is changed to a purely financial service, named confidential factoring or more commonly invoice discounting, where the client is released from the need to notify the debtors to pay directly to the factor and there is provided that all the debts sold to the factor should be subject to full recourse.

In the early days of invoice discounting, debts represented by individual invoices were sold to factors. This system gave rise to some difficulties: it was not always possible for the client to pass onto the factor the payment for the invoice in its original form as the payment might have been made after deductions for cross-claims or combined with payment of other invoices.

In recent years, the service of invoice discounting has been more usually provided on a whole turnover basis, by including all the client's sales or all his sales to particular customers. The client maintains the sales ledger and collects from the debtors on behalf of the factor to whom the ownership of the debts has been transferred, and arrangements are made for the proceeds of collections to be paid by the client directly to the factor's bank account.

Although it does not offer the three other services, the factor usually charges a small factoring commission too, apart from the financing commission. This charge is more like an engagement, because the factor has to grant financing for the client at request, taking into account the total amount of the debts. This commission covers the assistance given by the factor to the client for the debt administration and risk coverage, the expenses incurred by the factor in the process of monitoring the debtor, and for the business in general.

The client is obviously interested only in increasing his working capital, and invoice discounting is a flexible way to accomplish this. For the factor, invoice discounting is easily done, but implies that the client has a good administration system and solid knowledge in risk management. The factor has to regularly audit the client, to make sure that his financial situation and his administration standards are kept sound. Exceptionally, the factor may cover the risk of non-payment.

There exists also a form of invoice discounting in which the factor takes no responsibility for the administration or collection of the debts, the factoring is fully on a recourse basis, but the factor requires disclosure to the debtors. This form is referred to as disclosed invoice discounting. This system is used when the client has a large number of small debtor accounts; there are factoring companies that provide this service on a non-recourse basis, subject to the approval of debtor accounts.

IV.Maturity factoring

When financing is not required, an arrangement is made which comprises full administration of the sales ledger, collection from debtors and protection against bad debts. This service is called maturity factoring and can be defined as a full service factoring without the financing element.

This lack of financing makes the guarantees different. The risk consists only in debtors' risk; there is no seller's risk. For the same reason, there are no financing commissions, the factor being remunerated trough commission taxes.

The factor pays the client for the debts sold in one of the following ways:

•        after a certain period from the date of invoicing (i.e. 60 days), this being known as the maturity period. The benefit of this method is that the client knows exactly when he will get paid and can adjust his cash flow accordingly.

•        When every debtor pays his invoice or when the debtor is insolvable, on the condition that the non-payment risk is insured

To apply for this service, the client is supposed to have enough finance resources; he demands the factor to improve his weak debt administration, to diminish his indirect costs and to ensure coverage against non-payment risk.

V.International factoring

International factoring made after deductions for cross-claims or combined with payment of other invoices.

In recent years, the service of invoice discounting has been more usually provided on a whole turnover basis, by including all the client's sales or all his sales to particular customers. The client maintains the sales ledger and collects from the debtors on behalf of the factor to whom the ownership of the debts has been transferred, and arrangements are made for the proceeds of collections to be paid by the client directly to the factor's bank account.

Although it does not offer the three other services, the factor usually charges a small factoring commission too, apart from the financing commission. This charge is more like an engagement, because the factor has to grant financing for the client at request, taking into account the total amount of the debts. This commission covers the assistance given by the factor to the client for the debt administration and risk coverage, the expenses incurred by the factor in the process of monitoring the debtor, and for the business in general.

The client is obviously interested only in increasing his working capital, and invoice discounting is a flexible way to accomplish this. For the factor, invoice discounting is easily done, but implies that the client has a good administration system and solid knowledge in risk management. The factor has to regularly audit the client, to make sure that his financial situation and his administration standards are kept sound. Exceptionally, the factor may cover the risk of non-payment.

There exists also a form of invoice discounting in which the factor takes no responsibility for the administration or collection of the debts, the factoring is fully on a recourse basis, but the factor requires disclosure to the debtors.

This form is referred to as disclosed invoice discounting. This system is used when the client has a large number of small debtor accounts; there are factoring companies that provide this service on a non-recourse basis, subject to the approval of debtor accounts.

For many companies, selling in an international market place is the ultimate challenge. Different customs, currency systems, laws and languages still create barriers to trade. International factoring provides solutions regardless of whether the exporter is a small organisation or a major corporation, being used by exporters who sell on open account or documents against acceptance terms.

By outsourcing the credit function, exporters can convert the high fixed cost of operating an international credit department into a variable expense. Commissions paid to the factor are based on sales volume so costs fluctuate with actual sales, lowering operating costs during slow sales periods. In addition to relieving exporters of the time-consuming administrative burden of approving credit and collecting export sales, international factoring lets exporters safely offer their foreign customers competitive open account terms. Financing is provided by means of advances against outstanding accounts receivable.

International factoring provides the following benefits to the exporters:

  • Increased sales in foreign markets by offering competitive terms of sale
  • Protection against credit losses on foreign customers
  • Accelerated cash flow through faster collection
  • Lower costs than the aggregate charges for L/C  (letter of credit) transactions

International factoring provides also benefits for the importers:

  • Purchase on convenient 'open account' terms
  • No need to open L/C
  • Expanded purchasing power without blocking existing lines of credit
  • Orders can be placed swiftly without incurring delays, L/C opening charges etc.

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Comments 6 comments

Liberty 5 years ago

I have been looking around for some information on invoice factoring, debtor finance, business funding and some of these related topics and i found this article very informative.Thanks for proving such a good informative article


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SpiritLeo 5 years ago from Europe Author

Thank you for your visit and comment!


fear 5 years ago

thanks for the information. very helpful


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SpiritLeo 5 years ago from Europe Author

Glad you find it useful! Good luck!


Kumar sahib 5 years ago

Thanks for a good piece of Information about Factoring, I was looking for it as i'm onto my dissertation and it's my research problem , thanks once again


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SpiritLeo 5 years ago from Europe Author

Thank you Kumar! You are welcome!

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