Factoring is a complete financial package that combines export working capital financing, credit protection, foreign accounts receivable bookkeeping, and collection services. A factoring house, or factor, is a bank or specialized financial firm that performs financing through the purchase of invoices or accounts receivable. A form of factoring, export factoring, is offered under an agreement between the factor and exporter, in which the factor purchases the exporter's short-term foreign accounts receivable for cash at a discount from the face value, normally without recourse. The factor also assumes the risk on the ability of the foreign buyer to pay, and handles collections on the receivables. Thus, by virtually eliminating the risk of non-payment by foreign buyers, factoring allows the exporter to offer open accounts, improves liquidity positions, and boosts competitiveness in the global marketplace.
Factoring is recommended for continuous short-term export sales of consumer goods on open accounts:
- It offers 100% protection against the foreign buyer's inability to pay - with no deductible or risk sharing.
- It is an attractive option for small and medium-sized exporters, particularly during periods of rapid growth, because cash flow is preserved and risk is virtually eliminated.
How it works
The exporter signs an agreement with the export factor who selects an import factor through an international correspondent factor network, who then investigates the foreign buyer's credit standing. Once credit is approved locally, the foreign buyer places orders for goods on open account. The exporter then ships the goods and submits the invoice to the export factor who then passes it to the import factor. The import factor handles the local collection and payment of the accounts receivable. During all stages of the transaction, records are kept for the exporter's bookkeeping.
There are some limitations of factoring that must be taken into account. Factoring exists in countries with laws that support the buying and selling of receivables. It generally does not work with foreign account receivables that have more than 180-day terms. It is also not well suited to a new-to-export company as factors generally (a) do not take on a client for a one-time deal, and (b) require access to a certain volume of the exporter's yearly sales. Lastly, it may be cost prohibitive for exporters with tight profit margins.
Useful reading includes the Trade Finance Guide of the US Department of Commerce. Useful links include the webpages of the International Factors Group (http://www.ifgroup.com/) , and of the International Factoring Association.