What is factoring and how does it work?
Factoring is a service that finances sales invoices. A company that issues an invoice with a long payment term to its contractors turns to a factor and sells the document to him. The factor (this role is played by a factoring company or bank), pays the entrepreneur the amount due for the invoice less a commission, and from then on the debtor is obliged to pay the amount shown on the invoice to the factor.
There are many types of factoring, but today we will focus on the two most important from the point of view of receivables insurance. These are part factoring (with recourse) and full factoring (without recourse).
Do you have proven customers? Choose incomplete factoring
In this case, the factor (i.e., the entrepreneur using factoring) sells the invoice to the bank or factoring company, but the factoring company is responsible for the possible insolvency of the counterparty.
So what are the advantages of incomplete factoring (with recourse)? First of all, immediate recovery of liquidity – the funds from the invoice will hit the company’s account even in a few hours! And if it becomes necessary to repay the debt on behalf of the counterparty, the factor will grant the entrepreneur additional time to repay the funds, so that he will not have problems with payment.
What should we do when we have concerns that a trade counterparty may be insolvent?
If a business selling goods or services is concerned that its counterparty will become insolvent or otherwise unable or unwilling to pay an invoice, it can make arrangements to reinsure the receivable. There are two ways to do this.
Full factoring (non-recourse)
It is an all-in-one solution, allowing the entrepreneur to almost forget about the invoice he has issued to the contractor. In this situation, the factoring company takes over the receivable, pays the funds minus the commission, and then handles the collection itself. The risk of insolvency thus shifts to the factor, and the company can continue to do business, benefiting from the instant funds raised and unwavering liquidity.
Full factoring is especially recommended for companies that do not have their own legal or administrative departments, and thus debt collection can be a serious problem for them. It is also a solution for cautious entrepreneurs, often establishing relationships with new clients or doing business abroad.
Important!
Full factoring is more expensive than part factoring for the reasons mentioned above. Often, however, the terms of the factoring service can be modified and tailored to meet the needs of your business. An example would be partial liability for the insolvency of a counterparty – for example, up to a fixed amount, under a contract with a factoring company.
Insurance of receivables
Another way to protect against counterparty insolvency is through accounts receivable insurance. The principle of such insurance is simple: an entrepreneur can approach an insurance company and buy insurance for a specific receivable or a certain number of them. Some insurers also offer subscription plans that guarantee insurance for all claims during the contract period.
In such a situation, it is the entrepreneur who enters into a contract with the insurance company and negotiates the terms.
Important!
Insurance recovery takes longer than accessing funds through factoring. This is because, among other things, the entrepreneur can only begin to seek recovery of the money when there has been a so-called “loss of money”. chronic default, i.e. a certain period of time, agreed with the insurance company, has elapsed since the due date indicated on the invoice.
Transaction insurance is a good choice if the company’s liquidity is not at risk, but we have concerns about the timely payment of debts by the counterparty. We must also remember that the insurance company will not automatically pay out the insurance funds after the due date – it is the responsibility of the insured entity to try to recover the funds from the debtor.
So if you’re looking to secure your receivables and keep your company’s cash flowing, choose online factoring with insurance at PragmaGO.
