Suppliers often face the need to finance receivables (sales invoice) as larger buyers operate at deferred payment terms. Factoring allows companies to bridge cash flow gaps, but accessing such services can be challenging.
Traditionally, suppliers request factoring from banks, but may be denied for various reasons, from low volumes and poor creditworthiness to the complication of export transactions. However, there are a growing number of innovative financiers and financial products to service those who fall between the cracks. Alternative factoring companies and working capital marketplaces work with a broader range of buyers and suppliers than most banks.
How to calculate the all-in funding cost and uncover hidden fees?
Choosing your factoring partner is an important decision as out payment policies and financing costs can differ significantly. Hidden costs can make comparison difficult, so terms should be evaluated carefully.
When comparing costs, the supplier should look beyond the headline interest rate and instead work out the Annual Percentage Rate (APR). APR should take into account interest as well contract/limit and invoice handling fees.
For example, the advertised rates may be as follows:
Now suppose the limit / outstanding amount is EUR 100 000 at 30 day payment terms with 100 invoices per month, the annual cost becomes:
The APR would thus amount to EUR 5800 (2400+1000+2400) or 5.8%, which is more than twice as expensive than the base rate of 2.4%.
Which documents should the supplier prepare?
Factoring is vulnerable to fraud and simply set-offs or overdue payments, so banks aim to mitigate such risks.
In with-recourse factoring, the supplier takes responsibility for repaying the bank, so the supplier’s financial situation is of particular importance. Consequently, financiers expect to assess the company’s accounts (1-3 months of financial statements and the most recent annual report) to determine its overall credit quality. Information about the company’s owners, legal representatives, and customers is also analysed for compliance purposes.
For factoring in particular, financiers usually look at the supplier’s sales ledger alongside the bank statements. These documents prove transactions and shed light on customer payment behaviour. They also help calculate the expected outstanding amount, the average quantity of invoices, and exact payment terms.
In the financing stage, banks often expect buyers to validate invoices. Such confirmations can be requested for all invoices, but most large buyers reject that due to the manual processes created. Some buyers agree to confirm a limited number of invoices over email and banks will often settle for that. If such confirmations are not given, a bank is likely to refuse funding.
Why do buyers matter in factoring facilities?
When negotiating with the factoring provider, the supplier should pay attention to the profile of the buyers involved. They are essential: buyers are expected to pay the invoice and any payment deviations mean additional work for the creditor. Many banks also purchase insurance for the credit risk of the buyers and not every buyer is insurable. In short - a more diverse buyer base with reputable companies will allow the supplier to fund greater volumes at lower cost.
It’s a good practice for suppliers to inform the buyer that their invoices will be financed. In order to convince them to provide the necessary validations, the supplier should emphasise the reasons for doing so. The key advantages to the buyer are:
Factoring companies will evaluate the buyer’s credit profile and might even request their financial statements, even though the latter is only necessary for smaller buyers or in case public information is not accessible.
Once all the documents have been submitted and checks successfully passed, the next step is for the supplier to sign a financing agreement and get going.