The factoring

Factoring – fundraising easily

Many people believe that factoring is a new story, but it is a service created almost 200 years ago, which appeared in Hungary as early as the 1920s.

The concept of factoring

Factoring is nothing more than borrowing money against the purchase of an account receivable. The original owner of the account then sells this claim and the factoring company (i.e. the lender of the money) becomes the owner of it.

During the conclusion of the factoring contract, a receivable due in the future is sold, so it can be considered as a kind of assignment.

Why is factoring beneficial?

You may rightly be wondering why someone doesn’t take out a working capital loan for the 30-90 days while their customers pay, or why it’s worth it for a factoring company to lend in this way to even small start-ups.

The answer to the first question is very simple: it is possible that the company is not (yet) creditworthy. That is, in vain they want to take out a loan, either they can get it by providing too much collateral, or they can’t get it at all. In factoring, however, it is not him who is looked at first, but the stability of his customer is important. If the buyer is otherwise creditworthy, the loan against the account receivable will most likely be repaid.

Basic concepts in factoring

Factor

A financial institution that purchases a receivable and provides factoring services. Factoring may be granted in accordance with the provisions of the Civil Code on Factoring.

Claim

Remuneration for recognized and performed services.

Benefits of factoring

Fundraising is easy

Unlike large companies, the players in the SME sector do not (yet) have a large customer base, so it is extremely important for them to remain competitive without being over-indebted.
Factoring does not change your credit rating, yet you can increase the speed of money turnover.
Factoring doesn’t require you to be profitable (all you have to do is existing and working) and you don’t even have to submit a business plan. Last but not least, your ownership stake will remain.

Safety

In many cases, the factor takes on the tasks of collection, so your customers’ willingness to pay may increase. This will also increase your security. In addition, the factor leads to accurate administration, making it easier to keep track of who paid for which account and when.
You may be a two-legged excel spreadsheet, and you also know by heart how much you have had in your account for 3 months, 5 months and 12 days, but even written follow-up can be the key to resolving disputes.

Providing a competitive advantage

Sales should not be at the expense of maintaining your own financial stability. The article on liquidity has already talked about how liquidity not only means how much you have in your account, but also how your solvency will develop while you place that order.
By using factoring, you have the opportunity to take on orders that you would not be able to do without the invoice consideration.

Who is good at factoring services?

As factoring is an answer to the questions of liquidity management and working capital financing, it may come in handy for you if you

• are in a continuous supplier relationship or with one or more creditworthy medium or large companies
• want to give your customers a longer payment period in order to increase your sales opportunities or competitiveness
• can no longer raise your bank credit line for this need.
• have a constant need for working capital, but there is strong seasonality in your sales

When can you use factoring?

Of course, the main question here is how stable the company that pays you is.

Given that the most common type of factoring (at least in Hungary) is recourse factoring, it is also important here that your customer wants to pay and if your customer does not pay, there should be a chance to collect the already credited part.

Accordingly, you are expected to deliver a marketable product and give the customer correct (and formally correct) invoices. It may sound profane, but if you have a problem with these, your claims against the most civil partner will not be funded either. I don’t think you would do the otherwise.

In addition, banks typically expect you to operate stably, ie:

• have at least 1 closed year
• make your business work (i.e. bankruptcy or liquidation proceedings are an exclusionary factor)
• your equity should not be negative
• be solvent: have no overdue public debt or supplier debt
• banks can also prescribe a minimum annual turnover, which is basically not an unexpected expectation, they are already looking forward to an annual turnover of 100 million.

How factoring works

Regardless of the type of factoring, it consists of the following steps:

1. You submit an invoice to the buyer to the factoring company, indicating that you want to factorize.
2. The factor will review this and if it does not find a formal defect, it will pay you at the agreed rate. This is usually expressed as a percentage of gross value
3. The buyer pays the factoring company (this is typically a bank) by the specified deadline. (Silent factoring differs from this.)
4. Upon receipt of the consideration, the factoring company will settle with you for the non-credited portion.

Types of factoring

Factoring, like lending, is available in several forms. These are basically all about buying a receivable, but they differ in their level of service and thus in their pricing or just availability.

Recourse factoring

It is the most common tooth for factoring. The factor buys the receivable from the business, records and collects it, but the risk from lending remains with the customer. That is, if your customer still doesn’t pay, you have to stand up.

Non-recourse factoring

In this case, the factoring company pays even if the buyer would not pay. This means more security for your business, but at the same time, security comes at a price.
In the case of chargeback-free factoring, you fully transfer the responsibility for registration and debt collection to the factor.

Export factoring

It is similar to traditional factoring, with the difference that 2 factoring companies are here to help.
It increases your security during export activities. Then, as an exporter, you enter into an agreement with the domestic factoring company, he will be the export factor. He contacts the external factor (who is the import factor). The payment process will be as follows: your customer pays to the import factor, who transfers to the export factor, who pays you.

Undisclosed factoring

Then your buyer doesn’t know you sold the claim, he pays you the same way. You have previously received the consideration from the factor, so you offset this obligation from the consideration received.

Extent of factoring

There are basically 3 factors that determine how much you can get when factoring.

Customer limit

This is the maximum amount that can be provided for a given customer.
In determining this, the factoring company starts from the following:

• creditworthiness of the buyer (solvency)
• payment morale
• the size of your customer base
• payment deadlines
• degree of seasonality

A sudden change in any of the factors can, of course, change the limit in either a positive or negative direction.

Supplier limit

This applies to you up to the maximum amount they are given to you in total. You can also think of it as a line of credit with so much difference that most banks can ask for collateral for a normal line of credit that you can’t meet. Here, the consideration for the bills serves as collateral for the credit line. As your customers pay, they replenish your credit line, which you can then reuse. Building a customer portfolio with good payment morale also benefits you here.

Your load-bearing capacity is essential here. This means how much your customers will be able to pay from your existing reserves if they don’t pay.

Extent of the advance

The advance represents the amount that the factoring company will pay you as consideration for the invoice. This is typically 80% of the gross value, but this can be reduced by a counterclaim. If your customer also demands a certain amount from you (i.e. you are each other’s suppliers and customers at the same time), they can reduce the amount of the advance accordingly.
The amount of the advance, of course, actually means the advance. That is, after receiving the value of the invoice, you will also receive the remaining amount.

The price of factoring

The factoring fee consists of two items. From the factoring price on the one hand and the interest rate on the other.

Factor fee

Fixed fee based on gross invoice amount.
This covers the costs of the permanent services provided by the factoring company (eg administration), the amount of which depends on:

• the amount of invoices
• the number of transactions
• the magnitude of the cash flow

Interest

Interest due during the term. The factoring company usually charges daily interest here, so here again the advantage of a well-paying customer base comes back to you. You don’t have to think much about it here, the term starts from the submission of the invoice and lasts until your customer pays your invoice. That is, it lasts from a few days to the bill payment deadline.

Factoring in numbers

Suppose you want to factor an invoice with the following conditions (the numbers do not necessarily correspond to the actual market conditions, it was a priority for me to be easy to account for and thus easier to follow)

Gross value of the account:	HUF 1 million
Factor fee:	1%
Interest (This is always an annual interest rate):	12%
Financing rate:	80%
Payment deadline:	30 days
The factor fee was calculated for the gross amount of the invoice:	HUF 10.000
Amount financed:	HUF 800.000
You will receive immediately:	HUF 790.000

You will receive the unfunded HUF 200,000 upon receipt, reduced by the interest.

The factoring interest is calculated on the amount you also use:	790.000* 12%/12= 7.900
Amount received:	200.000- 7.900 = 192.100,- forint

Here, of course, you have to calculate daily interest. If the payment deadline is not exactly 1 month, the bank will calculate it in days. (It still counts daily, I just promised simplicity, and 30 days is 1 month )

In this case, the factoring of this HUF 1 million account costs you HUF 17,900

Is factoring expensive?

It’s a matter of perspective, so it depends. The factoring price is around 0.3-3% of the invoice value on average, depending on all other conditions.
The question of how much you could solve without factoring could be solved at all. Obviously, if you couldn’t solve it at all, it’s not a question of whether it’s expensive or not. This is at your disposal.
Before judging if it’s expensive, keep in mind that a factoring company isn’t just giving you credit. It also helps you with administration as well as debt collection, taking the burden off your shoulders. Not to mention that this gives you the opportunity to make money faster, which in turn increases your own profits as well.

Risk of factoring

Like all financial transactions, there are risks.

It is essential, however, that the factoring company only finances invoices issued to a creditworthy customer from completed, recognized deliveries. However, dust can get into the machine.

Customer risk

Your buyer will be tested for creditworthiness and financed only if it is stable. The risk is that the requested financial statement reflects the past and does not provide information for the future. Thus, in the event of a sudden change (when your buyer becomes insolvent, or only in the event of serious liquidity problems), on the one hand, you have to cope, and on the other hand, the buyer limit will be reduced accordingly.

The factoring company does not investigate whether liquidity problems have occurred at your customer due to faulty management or market changes affecting everyone. Accordingly, such a situation may affect you at a time when you yourself are facing liquidity problems.

Transaction risk

The nature of the product or service largely determines its factorability.

It is a matter of individual decision which industries or types of services a factor company accepts or excludes. Accordingly, it is possible that both you and your customer will meet all the conditions, but they will not factor that bill. This is due to the fact that the probability of disputes in a given industry is, in the opinion of the bank, high.

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