Factoring at a glance
Factoring is a type of financial service in which an entrepreneur can choose to sell invoices that he has previously issued to his contractors. These invoices are purchased by factoring companies and banks engaged in such activities. In a factoring agreement, the entity purchasing the invoice is called the factor, while the company selling it is called the factor.
By using the factoring service, the factor receives the funds it was expecting to be repaid almost immediately, while the factor in turn earns money from commissions and other fees associated with factoring.
It is worth mentioning that the conclusion of a factoring agreement between a factor and a factor does not de facto change the situation of the former’s counterparty – he will still be obliged to pay his dues on time and in the same amount, only the account number to which he will send the money changes.
What does an entrepreneur gain from factoring?
The main advantage of factoring for entrepreneurs is the ability to receive money right away – instead of waiting 30 or 60 days for repayment, a business owner can receive money the same day.
Gaining time also entails other positive effects – the liquidity of the company increases, and the entrepreneur gains funds that he can use to cover the current costs of running the company.
What’s more, factoring does not increase a company’s debt, which means it does not interfere with its credit plans. This is also very good news for those of the entrepreneurs who already have some liabilities and current business costs do not allow them to take out another loan from a bank.
Factoring is a convenient, safe and cost-effective alternative, which, moreover, is available to almost any business – even one that entered the market a few weeks ago.
When is it a good idea to opt for invoice sales?
There are many situations in which the use of factoring can prove profitable for a company – we will describe some of them with examples.
When invoice payment dates are far off
Sometimes entrepreneurs are somehow encouraged to issue invoices with long payment terms by the prevailing situation in the industry. Offering counterparties a longer repayment period is an element that increases the attractiveness of the offer and may prove crucial in the battle for customers.
EXAMPLE
Mr. Theodore runs a building materials store – his services are used by renovation and construction companies, whose finances are largely dependent on end customers, availability of materials and sometimes even weather conditions. As a result, they require Mr. Theodore to submit invoices with at least 60 days’ payment.
Competition in the market is high, and as a result, Mr. Theodore has little choice but to invoice according to industry practice. However, when the first delays began to appear, he decided to secure his company’s finances and use factoring for construction companies. It has activated a fixed factoring limit in PragmaGO and finances invoices on an ongoing basis, so that it receives payment for an invoice automatically when it is registered in the Client Zone.
When a company needs funds for payouts
Among the ongoing costs of doing business is, if the company employs workers, the timely payment of salaries. Factoring can ensure that disbursement expenses are not a major problem.
EXAMPLE
Ms. Catherine last year decided to invest a certain amount of money in expanding her business. It has hired several employees, purchased the necessary equipment and started providing new services. However, business is turning a little slower than she had anticipated, yet Ms. Catherine has reason to believe that the cooperation she has just established will finally push the company on the right track.
The entrepreneur is keen to retain the entire team she has hired, as she has grown close to her employees and appreciates their contributions to the company. As a result, it has opted for online factoring. She sold the invoices she was waiting to be paid to a factoring company, and in return paid salaries, sorted out Social Security contributions, bookkeeping, and paid other administrative and fiscal fees.
When the bank refuses to lend
If a company invests, acquires new equipment or means of transportation, it most likely uses investment loans or leases for this purpose. The former not only burden the company’s budget, but also constitute its debt, so that when there is a need to obtain financing for other purposes, it will be difficult to count on the bank’s help.
The bank may refuse to lend not only because of insufficient creditworthiness (although this is the main reason for loan denials), but also because of the company’s seniority. Some banks do not grant loans to companies operating for less than 12 months, but most require a minimum of 24 months between the establishment of the business and the time of the loan application.
EXAMPLE
Mr. Jedrzej runs a transportation company. He has a business loan and several cars on finance leases. The financial situation of Mr. Jedrzejo’s company is stable – he pays loan and lease installments on time, salaries go to employees on time, and customers appreciate working with him.
Mr. Jedrzej parks part of his car fleet in garages located at the company’s headquarters, but a few cars are parked on a private lot next to the entrepreneur’s home. When an opportunity to buy garages located right next to the company’s headquarters comes up, Mr. Jedrzej intends to take it, but he knows that the bank will not give him a loan because of the liabilities he already has.
However, there is a way out of this situation. Mr. Jedrzej chooses factoring for transportation companies and sells a dozen or so invoices that he expects to be paid. He receives money from the factor and buys garages. This will save him a lot in the long run – not only on employee trips between his lot and the company’s headquarters, but also keep the cars in better condition, as they will be safely garaged from now on.
Learn more about the differences between factoring and credit
When an entrepreneur wants to generate a deductible expense
Although using factoring solely to generate business expenses is not the best idea, it is worth bearing in mind that the fees associated with factoring services (including service fees or limit maintenance) are tax-deductible and as such reduce the company’s income tax.
This is another of the many reasons to use factoring, and thus take care of the company’s liquidity and regain access to frozen funds.
