Increasing cash flow with factoring

Paul Smitherman |

How to access funding and maintain sustainability

One of the major challenges for medium-sized and large companies is how to finance the lack of equity capital in order to develop the business and benefit from expanding market opportunities. In today’s economy, where companies must be ready to make concessions in terms of payment deadlines to close deals, it has become more difficult to secure loans from banks and other funding sources. This situation has moved many companies to lose necessary liquidity to operate in peak seasons and be able to budget ahead with confidence. 

Companies expanding into new markets need to access liquidity, optimise working capital and mitigate credit risks as a basis to gain more customers and ensure sustainable growth. In addition, sufficient liquidity enables companies to secure early payment discounts with suppliers and take advantage of volume discounts, which lowers the cost of inventories and thus improves working capital.  

Factoring: a viable alternative to bank loans?

One of the most common alternatives for businesses needing liquidity is factoring, which involves a third party, the factor, purchasing corporate account receivables and providing nearly the full outstanding invoice amount as immediate cash to cover urgent commitments, operational activities and to develop the business.  

Unlike bank loans, factoring lending decisions are based on the quality of receivables rather than the corporate credit score, financial ratios and historical financial performance. A factor provides liquidity that grows directly with sales, empowering companies to fulfil high-volume orders as opposed to a bank credit line that is capped with only recurrent revenues.  

In addition, factors will credit check customers protecting the business from bad debt by providing advice to set credit limits where necessary. They can also optionally take on a complete account receivables management offering, debt monitoring and collection services. 

How does factoring work? 

Factoring starts with a company selling account receivables to a factor often between a minimun and maximum financing volume that has been agreed in the factoring contract. The factor advances usually about 70 to 85% on approved invoices within a day or two, allowing the company to generate additional cash-flow. The process is completed when customers pay their outstanding invoices and the company gets the remaining percentage less the factor charges fee. 

The type of factoring contract being either recourse or non-recourse defines the responsibilities in case an invoice is not paid. In recourse factoring, the company selling receivables assumes the risk of default by the customers, having to compensate the factor in the event of non-payment. In non-recourse factoring the factoring contract includes credit protection within the cost of services and the factor accepts the risk of non-payment, so that receivables are protected against bankruptcy and insolvency. 

Factoring charges are based on company’s total sales volume, industry, market position, customer’s portfolio risk and invoice payment terms. Companies selling receivables can expect a small factoring fee per invoice item and in some cases an interest on funds advanced, normally applied on a monthly basis. Depending on the factor, there might be some other costs such as yearly minimum sales volume and invoice minimums. 

Since factors are usually private entities and not as strictly regulated as banks, they have less credit requirements and bureaucracy enabling companies to get cash flow faster and with more lending flexibility. However, factoring costs are usually higher than bank interest rates.  

With a factoring contract companies can accelerate payments every time they need additional liquidity by selecting invoices and amounts to be factored that fulfil contract agreements. Since factoring is not a loan, companies do not incur any additional debt, also enabling them to improve the own balance sheet and equity ratio. 

Reducing the administrative workload

In day-to-day business transactions, companies with a large customer base and high volumes of account receivables with a need for increased liquidity periodically have a considerable workload to administer factoring contract agreements. An example of this would be to accurately filter the accounts receivables that are eligible to be purchased by the factoring to generate additional cash. 

Some key factoring contractual agreements cover maximum and minimum financing volumes, eligible invoices sorted by due date or amount, overdue days, eligible countries and currencies, financing limits per contract and customers. They also optionally cover insurance limits as the basis for financing volume per customer, voluntary or obligatory repurchase of overdue items by the company as well as all necessary communication files in the format required by each factor in order to process and approve additional funding. Communication files may include debtors, sales invoices, last payments, dilutions, repurchases and rejections from the factor. 

In order to minimise administrative handling and optimise outcomes of factoring contracts, there are software solutions on the market that can be integrated within the same system environment in which the company processes all account receivables that offer efficient support to manage factoring transactions.

Leading software solutions enable simulations of the saleable invoice portfolio with just a few mouse clicks and can even automate selling notifications to the factor to ease cash flow generation while remaining compliant and auditable. Where the factoring contract is combined with credit insurance, these solutions can also handle insurance limits per customer within the simulation and process selling notifications to the factor. 

Finding the right software solutions with SAP Credit Management Suite

Part of the SOA People Credit Management Suite and a very well established SAP AddOn solution is the Asset Backed Securities solution ABS/Factoring Management. Based on mapping of factoring contracts, this software enables account receivables sales to be fully automated in SAP through seamless integration.

It enables you to check the saleability of all account receivables and generate cash simulations through a free definable automated process or manually with just a few mouseclicks. The application also delivers accurate cash simulations both in recourse and non-recourse factoring variants and in combination with credit insurance limits. Factoring and insurance data is displayed in the customer item list in SAP showing both insurance and factoring status per invoice in a single overview. 

ABS/Factoring Management can perform maturity analysis of the financing portfolio and, if agreed with the factor, supports the voluntary and obligatory receivables purchase, keeping factoring decisions auditable in the system at any time. The solution remains easily readjustable to reflect changes in the factoring contract conditions and can easily connect to different factoring institutions such as BNP Paribas, Commerzbank, and Eurofactor, fulfilling specific requirements for the data exchange with the factors. 

ABS/Factoring Management can be used in combination with Information Management from the SOA People Credit Management Suite to interface with information agencies such as D&B, Bonicheck Euler Hermes and Creditreform in real time to automatically exclude customers from the account receivables sales, when the creditworthiness level is less than the agreed threshold. 

Where receivables management and collections are not included in the factoring contract, ABS/Factoring Management can be used in combination with Dispute Management for a faster dispute resolution in SAP, avoiding paying increasing outstanding fees to the factor.

Using the Credit Management Suite, companies can automate the whole process, providing a greater degree of software flexibility and remaining independent from factors, insurers and credit bureaus to boost working capital and increase revenues with the most efficient and convenient partners in any time. 

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