Loan Factoring – definition, what is it and how to use it?
To maintain or regain the financial liquidity of the company, i.e. the ability to meet current obligations, the entrepreneur may use factoring. What is it about and what are the consequences of using such a financial service by an entrepreneur?
From the definition of factoring, it is a financial service with two sides: a factoring company, i.e. a factor, and an enterprise, i.e. a factoring company. Factoring is the purchase by the factor from the factoring agent of overdue receivables resulting from invoices for the sale of goods or services.
The concept of factoring definition
Factoring allows you to immediately obtain a larger portion of payments for invoices with a longer payment period. It can be said that the definition of factoring is a form of short-term financing for companies that grant trade credits to their clients, i.e. they use deferred payment terms for contractors.
Other benefits for the entrepreneur may go hand in hand with the factoring service. He can not only get instant access to cash, but also a package of additional services, which may include monitoring and enforcing payments. The factor can also take over the risk of customer insolvency. It all depends on what type of factoring we are dealing with in a given case.
Legal basis for factoring
There are no provisions specific to factoring contracts in the Polish legal order, which is why they should be referred to as unnamed contracts. The provisions of the Civil Code apply to them. In art. 509 of the Civil Code, it was stated that: “The creditor may transfer the claim to a third party without the debtor’s consent unless it would be contrary to the act, contractual reservation or liability. Along with the claim, all related rights are transferred to the buyer, in particular claims for overdue interest. “
In addition, art. 353 1 of the Civil Code indicates the freedom of contracts and according to it the parties may conclude them and arrange a legal relationship at their own discretion, but so that its content or purpose does not contradict the properties of the relationship, law or the principles of social coexistence.
The court rulings show that a factoring contract is a mixed contract, consisting of several typical contracts, which are regulated by law. Its main element is the transfer of claims but in conjunction with the service provided by the factor. At the same time, it is a paid contract, which means that in exchange for the transferred claim, the factory receives funds, the amount of which depends, among others on the extent of the debtor’s insolvency risk.
In accordance with art. 487 § of the Civil Code, factoring is a mutual contract that obliges both parties. The provision of one of them is intended to be equivalent to that of the other party. There are also provisions regulating the functioning of factoring services in international law. In the UNIDROIT Convention on International Factoring of May 28, 1988, i.e. the Ottawa Convention, factoring was defined as a contract concluded between two parties, according to which the factor (entrepreneur) transfers to the factor (factoring company) the claims arising from the contract of sale of goods or services concluded between him and his debtors. Definition of factoring according to the Ottawa Convention, the debtor should be informed about the transfer of ownership of the claim.
What are the types of factoring?
Factoring uneven, so you should know the key differences and similarities for its various types. Factoring agreements can be divided into those that represent debt factoring, commonly referred to as factoring, as well as debt factoring agreements.
In the case of debt factoring, the entrepreneur does not have to wait for payment of the invoice by the contractor but can transfer it to the factor and obtain payment. Money that affects the accountant’s account in this way can be used for any selected purpose. In most cases, when it comes to factoring services, we will be dealing with debt factoring.
Only a few agreements relate to debt factoring. In his case, the factor covers the client’s obligations to suppliers and contractors. The factorer gains time to collect the necessary funds and pay for his obligations. Business loans for companies work more or less in the same way. However, debt factoring differs from them in that it does not reduce the factor’s creditworthiness, has no negative impact on the company’s balance sheet and does not require the use of hard collateral. It can be obtained much faster than loans or business loans.
Considering whether the factor takes the risk of customer insolvency from the factor, we can mention full factoring, called recourse factoring, as well as incomplete factoring, which is also referred to as recourse factoring.
Full factoring is a form of factoring service in which you do not have to return the advance paid by the factor if it happens that the debtor does not pay on time. The factor assumes the risk that the customer’s contractor will turn out to be insolvent or will unreliably meet his obligations. On the shoulders of the factor with full factoring, without recourse, rests debt in cooperation with, for example, the insurer of receivables. The factor must take over the risk of insolvency and assume recovery costs. The factoring has a guarantee that he will recover the amounts due and free funds.
Incomplete factoring, i.e. recourse factoring, means that at the beginning after signing the factoring contract, the factor pays money to the factorer for the invoices issued by the customer. However, if the debtor does not pay on time, the factorer is obliged to return the advance payment. The entrepreneur must then undertake the recovery himself and the recovery process is his responsibility. The factor does not accept the risk of insolvency of debtors of the factorer.
Debt factoring can take the form of explicit and silent factoring. Explicit, also known as open is that the entrepreneur’s contractor is immediately informed of the fact of concluding a factoring contract. In this case, the expenses due to commission and interest for the service can be included by the entrepreneur as tax-deductible costs.
Silent factoring is the opposite of explicit factoring. In this case, the contractor is not informed at all that the entrepreneur concludes a factoring contract. Therefore, he repays the liability not to the factor but to the client factor. From his perspective, nothing changes. Most often, silent factoring is used by those entrepreneurs for whom the contract with the contractor has a restricted prohibition on the assignment of receivables.
There is also semi-open or semi-factoring factoring when the contractor does not know about the factoring agreement and assignment of receivables at the beginning, and he learns about it when he receives a request to pay the liability.
How to choose a factor?
The choice of a factoring company is crucial for an entrepreneur who wants to ensure ongoing financing of operations and maintain financial liquidity. Business loans, to which factoring can be compared, will be beneficial if the cooperation between the factor and the factor is in the right way. The problem is the choice of a factoring company from at least a dozen that operate on the Polish market. These are both independent companies and companies with links to banks and financial institutions.
The main criteria for choosing a factoring company should be:
- factor’s credibility on the market,
- service price,
- additional business services that the client can use.
It’s best to sign factoring agreements after making sure that the factor works reliably and runs a reliable company. Her reputation can be checked based on testimonials from other clients. One can also confirm the credibility of a factoring company in industry organizations – the Polish Factors Association operates in Poland, and the International Factor Group and Factor Chain International operate worldwide.
For entrepreneurs who want to use factoring, the costs of this service are very important. They are shaped by the factor’s commission, which is calculated as a percentage of the gross amount of financed invoices. Interest must also be added.
With individual invoices sold to the factor, most often it is not possible to negotiate the price conditions, but with high turnover transferred to the factoring by the entrepreneur, it becomes possible. Usually, the costs related to factoring are set individually with the client by the factoring company.