In finance, the term factoring refers to a practice in which accounts receivable (payments due) are sold to a third party at a discount in exchange for immediate payment. The third party then collects the payments at their full face value, earning a profit on the difference. The term is synonymous with accounts receivable financing.
Businesses may use factoring to stabilize their cash flow when their financial situation does not allow them to wait until payment of each invoice has been settled. Factoring also relieves businesses of the risk associated with providing goods and services in advance of payment – such as late or failed payment of invoices by customers.
In the factoring process, a company sells its accounts receivable to a financial services provider known as a factor. The factor fronts the money owed by the company’s customers – minus its commission. The factor then handles the collection of the accounts receivable. The factoring agreement ensures that the company receives a steady income regardless of whether or not its customers pay their bills on time.
A number of specialized factors provide factoring services in Switzerland. Some of these are represented by the Swiss Factoring Association. Some Swiss banks also offer factoring services or partner with specialized factors.
Example of a factoring arrangement:
An importer of raw materials enter into agreements with 5 manufacturers to supply them each with 100 tons of raw materials per year. Each of the 5 accounts receivable is worth 30,000 Swiss francs per year, and payment must be settled by the customers within 1 year. The problem is that the importer must pay for the raw materials and the shipping in advance. In order to maintain its imports throughout, the importer must obtain cash at the beginning of each year.
The importer could try to obtain a bank loan to finance its activities until it can collect payment on its accounts receivable. However, obtaining a bank loan is difficult, and the importer would risk defaulting on loan repayments in the event that its customers failed to settle their accounts on time. The interest charged for business loans is also significant.
The importer opts to use a factor instead. The factor buys the 5 accounts receivable at a guaranteed rate of 26,000 francs per year and account, paid at the beginning of every year. Although the importer receives less money than they would have if they were able to cover their costs and collect their accounts receivable themselves, they have the benefit of having a guaranteed income at the time they need it. They also avoid the administrative work involved with collecting payments. The factor now carries the risk of not being able to collect the accounts receivable – if the manufacturers delay payment or go bankrupt, for example.
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