Businesses can have a problem – large accounts receivable: someone owes a lot, and there are not enough funds for current expenses. There may be various reasons for this: for example, a supplier sells goods with delayed payment. Because of this, his accounts receivable – the right to demand payment from buyers – grows. On the one hand, the supplier knows that he is owed and will receive a large sum in six months. On the other hand – during these six months it is necessary to pay taxes, employee salaries and rent, and it is not clear on what money. Factoring solves this problem.
How to make the director repay the debts of the company?
Parties to factoring. There are three parties involved in factoring:
- The client.
- Debtor.
- Financial agent.
A financial agent is a person who provides the client with services to support monetary claims. Sometimes a financial agent is called a factor – these are synonyms. Any commercial organization, including banks, may be a financial agent.
The client is a person who assigns monetary claims to the factor and pays for its services.
What is an agency agreement
Previously, factoring was understood as the purchase and sale of the right to demand payment for goods sold, services rendered or work performed. But such a definition was similar to another contract – assignment of a claim. Besides, it did not correspond to international practice, according to which factoring is always a complex of services.
Now factoring is a complex of services on repayment of debt, which the financial agent renders for assignment of this debt.
A set of such services is assembled like a sandwich. There is a basic element, a kind of sandwich bun: the client concedes monetary claims to the factor and pays for his services. There is a filling, which the parties choose: at least two services from the following list:
- Financing, including in the form of a loan or pre-payment.
- Settlement of the client’s claims against third parties.
- Realization of claims against debtors, such as demanding payment of a debt, receiving payments from debtors.
- Checking, controlling or collecting collateral, dealing with guarantors or insurance companies.
If desired, the parties can add “sprinkles and gravy” – additional services. For example, bookkeeping, processing of debtor registers, inventory of receivables, insurance, etc.
Differences from an assignment. Cession is simply an assignment of a claim. In a cession, the one who has the right to demand something transfers that right to another person. A cession agreement is often used to formalize the sale of debts.
Cession is a mandatory element of factoring: the client assigns monetary claims to the factor for services rendered. But factoring is not limited to cession. In addition, it includes elements of other contracts: loan, sale and purchase, provision of services.
MFI: what it is and how it works
In cession, both monetary and non-monetary claims can be assigned, for example, the right to take goods from the seller’s warehouse can be assigned. In factoring, on the other hand, only the assignment of claims to pay money is allowed.
Differences from forfeiting. Factoring is used for short-term financing. The average term of factoring is 90 days. It is risky to provide money for a long period of time: the debtor may not be able to pay his debt. To minimize this risk, sometimes another type of financing against assignment of monetary claim – forfeiting – is used.
How to conclude a contract for the provision of services
Forfeiting is most often used in foreign trade export transactions.
As in factoring, forfeiting has three parties:
- Creditor – one who has a monetary claim against the debtor.
- Debtor – one who is obliged to pay the debt.
- The forfeiter is the one who pays the creditor’s claim for the debtor.
But the transaction is structured differently. The debtor pays the creditor with a promissory note or issues a letter of credit in the creditor’s name. The forfait pays the creditor for the debtor, and in return, the creditor gives him the promissory note or re-issues a letter of credit in his name. The forfait may then wait until the due date or sell the promissory note or reissue the letter of credit to another holder without waiting for the due date.
What is a letter of credit
A bill of exchange and a letter of credit are unconditional obligations of a debtor to pay a certain person. The debtor is no longer owed by virtue of the fact that the creditor has rendered him some service, performed work or sold goods, but by virtue of the executed bill of exchange or letter of credit. The content and legality of the original contract between the creditor and the debtor should not concern the forfeiter.
In factoring, however, the factor must be convinced of the reality and economic feasibility of the debt sold to him. Therefore, in the framework of forfeiting, financing can be provided for a longer period of time – even for several years.
Sometimes forfeiting is considered a kind of factoring. But this is not the case, because forfeiting does not provide the creditor with debt recovery services.