A very interesting financial instrument at firms disposition is the factoring, it lets small and medium firms get easy and cheaper financing. Traditional credit financing involves placing the corresponding analysis upon the firm. Well, the factoring puts the risk assessment upon the clients of the firm. This alone constitutes a very beneficial feauture for young and small firms that otherwise could not get bank lends and financing. The quality of the buyers matters for the factoring and good and established firms will perform better.
The mechanics is simple: a firm sells products which another firm buys, but promises to pay 30, 60 or 90 days later. As in many cases normally happens. But the seller needs the cash in order to continue its production or to service previous compromises. This is when the factoring comes because the seller can issue the invoice to a factor. The factor then pays between 60-90% of the invoice value. The difference is called “the reserve” and will be paid once the factor charges the whole operation value to the buyer. Obviously fees and accesory charges may apply (discount rate) measured in interest percentages.
Factoring performs basically in the business to business realm, where firms deliver unfinished products in a industrial oriented chain. This is really common all around the world and slowy is becoming more and more used. Factoring applies to deals between private firms but also in private firms and government dealings. In the case of the public sector the benefits revolve around effective resource spending and governance correct performance.
Factoring poses and excellent option for firms around the world and in many places it is the only way firms can get proper financing in order to continue their normal operation. Even in nations where there are not the best -so speaking- laws to protect and enforce commercial contracts, because it weights the risk in the buyer rather than in the seller.
It’s a winning strategy to enact collateral, bankrupcy and factoring acts in order to impulse financial and economic growth in emerging nations.
Klapper, Leora, 2005 “The Role of Factoring for Financing Small and Medium Enterprises” World Bank Publications