What is factoring? How it works and its advantages.

30 days. That’s the deadline set by the French government for settling an invoice. In some instances that timeline is extended to 60 days from reception. A timeline that especially for freelancers can quickly create cash flow issues.

The later customers pay their invoices, the harder it is for a freelancer to pay their essential costs (taxes or any other professional expenses [link in French] related to their business…), putting the overall development and long-term survival of their business at risk.

There’s a solution out there that allows you to get your invoices paid fast, sometimes even in a matter of days: factoring.

How does it work? Who is it for? What are its advantages? This article covers it all.

Factoring is a funding and debt collection solution for companies. It allows businesses to quickly collect payment for their pending invoices.

It works like this: a business sells its outstanding invoices to a factoring services company (sometimes referred to as a factor). The factor pays the business the amount billed on each submitted invoice (minus their service fee, which we’ll detail later on). It’s then the factor’s job to collect payment from the business’ customers and assume the risk of them defaulting on payment.

The business is bound to the factor by a factoring agreement (or contract).

This contract allows the factoring company to perform three kinds of services:

• debt collection: this covers all the administrative tasks related to invoicing: tracking, follow-up, payment processing;
• financing for customers’ debts: i.e. advancing the business the money owed to it by customers;
• credit insurance: protecting the business from defaulted payment and checking the customers’ solvency.

As you would expect, factoring services aren’t free. The factor takes a commission for each payment it collects on behalf of the client company.

There are three types of fees they can charge for their services.

This is considered to be compensation for advancing their client (the company) the money they’re owed on their outstanding invoices.

This fee is based off a banking rate called the Euribor (Euro Interbank Offered Rate), to which the factor usually adds 2 to 4% on average.

The factoring fee covers any services rendered that relate to invoice management (follow-up fees, debt recovery fees…).

This rate can vary anywhere between 0.2-2% of the invoice amount (including tax).

This rate can also increase according to:

• the number of invoices they’re given to process, as well as their billed amounts;
• the riskiness of the debt;
• the number of defaulted payments the client company has faced over the years.

A guarantee fund is a reserve of money that the factoring company sets aside to shield it from any potential defaults on payment.

This fund is supplied by a fee the factor levies on the invoices it’s purchased at a rate of around 10%. This fee is given back to the client company if the factor manages to receive payment for the client company’s invoice.

A word of caution: certain factoring companies have additional fees, like processing fees, potential litigation fees, subscription fees, etc. Be sure to look over your factoring agreement with a fine-toothed comb to avoid nasty surprises down the line.

Let’s use an example to better understand how factoring fees are usually calculated.

In September 2022, Company A sold a €1,000 invoice to a factoring company. As we’ve seen before, there are a few fees that could apply in this instance.

• A financing fee based off the Euribor rate (0.54% at the time of sale) with an additional 2% added by the factor, which comes to 2.54%. 1,000 - 2.54% = 974, i.e. €26 for the financing fee

• A factoring fee, set at 1% by the factor. 1,000 - 1% = 990, i.e. €10 for the factoring fee

• Contribution to the guarantee fund, set at 10%. 1,000 - 10% = 900, i.e. €100 will be held temporarily held for the guarantee fund, to be returned to Company A if the factor managed to retrieve payment for the invoice without incident.

Company A will have to pay a total of €136 on the €1,000 invoice they’ve given over to the factoring service. If the factor manages to get the invoice paid without any issues, the fee will be €36.

Factoring can prove helpful for businesses of any size or industry, really. However, only Business-to-Business (B2B) invoices are eligible; you can’t use factoring services if you bill your services to individuals.

The are three main benefits of factoring.

Thanks to factoring, you don’t have to wait the usual 30 to 45 days to get paid. The factor pays your pending invoices in a matter of days. Making managing your cash flow that much easier.

Factoring is also a great way to protect yourself from any payment hiccups. The factor takes on this risk by “buying” your invoice. Just be sure to read the fine print of your factoring agreement to make sure that there’s a clause that protects you in the event of default.

Selling your invoices to a factor takes the work (and time) out of chasing down payments. So you can focus on what matters most: your business.

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