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What is factoring and how does it work for companies?

In recent years, there has been a disproportionate increase in the need of companies to obtain credit in order to keep cash flows under control – not least because of considerable difficulties in collecting payments from debtors.

Factoring has thus become an increasingly indispensable tool for SMEs, although there is still a lot of confusion around the term. Let us see if we can clear some of it up.

What is factoring?

Factoring is a contract whereby a company sells existing or future receivables to a specialised company to obtain immediate liquidity and a series of services related to the management of the receivables sold, i.e. their management, administration, collection and advance payment before they come due.

The factoring company, therefore, assumes the burden of collecting the amount of the receivables in return for a fee and often also provides financing to the client in the form of advances on outstanding receivables.

The statute applicable to factoring is the Civil Code (in the part regarding the transfer of receivables), which provides for the possibility of transferring any receivable, unless the cooperating companies have excluded such a possibility in the commercial contract. Factoring, therefore, is an atypical contract that is applied under certain conditions:

  • The seller must be a business;
  • The assignment of receivables cannot be prohibited in a commercial contract;
  • The receivables sold must relate to contracts entered into by the seller in the course of business.

Who is involved in factoring

There are essentially three parties involved in a factoring contract:

  • the factor, i.e. the specialised operator that takes over, manages and finances in advance part of a company’s receivables;
  • the seller, i.e the company that sells its trade receivables to the factor in return for liquidity;
  • the debtor, i.e. the company with which the seller has a supply contract.

How factoring works and why it should be used

The use of factoring is especially widespread among companies that operate in sectors in which deferred payment to customers is a critical factor of success, but also among SMEs that work with public administration and often must deal with payment schedules that are difficult to reconcile with suppliers’ financial needs.

The seller receives the amount of the receivables sold before they come due, less a fee that constitutes the factor’s profit. A factoring contract is thus a true financing transaction for the client, which obtains the cash needed to pay its suppliers and continue to conduct its business, while avoiding defaults due to late payments by its customers.

And at a time when a reputation as a healthy business that makes prompt payments is increasingly indispensable, factoring can indeed prove to be a vital tool for SMEs.

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