What is Factoring
History of Factoring
Factoring has a long and rich tradition, dating back 4000 years ago, to the days of Hammurabi and the Mesopotamian civilization. Almost every civilization that valued commerce has practiced some form of factoring, including the Romans, who were the first to sell actual promissory notes at a discount. Closer to our own era, factors arose in England, as early as the thirteen century, acting as commissioned merchants for manufacturers in distant and unfamiliar markets. These factors relieved the manufacturers of the selling and credit collection responsibilities and specialised themselves in assessing the market's risk and collecting the money due.
The first widespread, documented use of factoring occurred in the American colonies before the Industrial Revolution. During this time, cotton, furs and timber were shipped from the colonies. Merchant bankers in London and other parts of Europe advanced funds to the colonists for these raw materials, before they reached the continent. This enabled the colonists to continue to harvest their land, free from the burden of waiting to be paid by their European customers. Just as today, the factors of colonial times made advances against the accounts receivable of the clients, enabling them to continue with their operations, long before they were paid for their products. With the advent of the Industrial Revolution, factoring became more focused on the issue of credit, although the basic premise remained the same. By assisting clients in determining the creditworthiness of their customers and setting credit limits, factors could actually guarantee payment for the approved customers.
Today, factors exist in all shapes and sizes: as divisions of large financial institutions or, in large numbers, as individually owned and controlled entrepreneurial companies. Modern factoring started in the United States of America, and then, as a result of pressure from the joint ventures between American factoring companies and local partners, it rapidly established itself in Western European countries in the mid 60's. Although the late 80's were characterized by a slight stagnation in the factoring worldwide, the market is now experiencing renewed vigour.
"A factoring operation consists in the transfer of commercial receivables of the owner to a factor, which assumes the obligation to cash them in, even in the case of temporary or permanent incapacity of the debtor. The factor can pay in advance all, or only a part of the total amount of the transferred receivables." (Bank of France).
"Factoring is the operation through which a company sells its 'Clients' accounts to a factor." (Bank of Britain).
In other words, factoring is a financial activity whereby the credit rights of companies carrying out sales transactions on maturity instalments terms are purchased by financial institutions named "factoring companies''. The factoring company immediately pays a certain percentage of the credited sales in cash to the selling company and pays the remaining part after it collects the amounts due from the debtors of the invoices sold.
Factoring is a financing tool that provides a company with immediate working capital, without creating debt or forcing it to give up part of its equity.