What factoring is all about
Let’s first explain the principle of factoring in general. It’s essentially a simple financial service aimed at entrepreneurs who need instant access to funds from invoices.
It is not uncommon for companies to be forced to issue sales documents with distant payment terms, which exposes them to liquidity problems – if a company does not receive payment for a completed order on time (or the due date is pushed far back in time), it may itself have trouble paying its own obligations. What’s more, the entrepreneur must pay income tax on the invoices issued, even if he has not yet received the money for the product or service sold.
How does factoring work? Example
EXAMPLE
Company A accepts an order from Company B to build twenty benches to be erected in a park located on land owned by Company B. These benches are to be built strictly according to the design provided by the investor and include an engraving with the company’s name. The parties to the transaction agree on a 60-day payment term. This means that Company A will have to execute the order and pay the resulting income tax long before it receives payment for the work performed.
Wanting to prepare for such an eventuality and minimize the risk associated with the possibility of an investor pulling out of the project, Company A decides to use factoring. In this way, it will receive more than 90% of the amount shown on the invoice right away, and the risk of insolvency for Company B will be assumed by the factor.
This is, of course, only an example. There are many types of factoring and many additional services that allow the factoring company to protect itself as thoroughly as possible against possible complications.
What is the difference between standard factoring and local government factoring?
Factoring is most often used by entrepreneurs who want to instantly regain access to “frozen” funds resulting from concluded transactions. If an entrepreneur has issued an invoice with a distant due date on behalf of local government units, we are dealing with local government factoring.
Orders in which local government units are the contractor are among the stable ones and usually provide work for the company for longer periods, which is why entrepreneurs are eager to choose realizations for the public sector. However, this does not change the fact that TSUs are also eager to use deferred payment mechanisms, which could potentially expose businesses providing them with services to the occurrence of payment bottlenecks. That’s why companies are looking to finance invoices issued to local governments.
With just such situations in mind, factoring companies offer their clients local government factoring, which is distinguished by preferential terms. Why can entrepreneurs expect better terms when they provide services to a local government unit?
As a rule, TSU is a client with whom cooperation does not carry a lot of risk – it usually does not have solvency problems, but rather has a strictly defined budget. So, in exchange for the promise of a hassle-free relationship, factoring companies offer better financial terms and a less restrictive system for assessing a counterparty’s financial situation.
How does local government factoring work? Step by step
In order to use local government factoring, an entrepreneur must go through a similar path to any other type of factoring. Here is the whole process in a few steps:
- Signing a contract with a contractor (in this case it must be a local government unit). The contract should indicate which services are to be provided or which goods are to be delivered.
- Issuing an invoice – the entrepreneur generates a sales document on. service or supply of goods and delivers it to the TSU.
- Submission of an invoice for financing – the entrepreneur visits the facturer’s website and submits the issued invoice for local government factoring.
- Choosing the right type of factoring and agreeing on the details – the factor and the factor agree on the terms of cooperation: they choose the type of local government factoring, select additional services and sign the factoring agreement.
- Verification and disbursement of funds – the last step is the assessment of the counterparty’s financial situation (in the case of local government factoring, this step is shortened as much as possible) and the disbursement of funds – the entrepreneur receives the money in his account within a few hours instead of waiting for repayment until the date specified in the contract with the client.
