Definition of Factoring
What Is Factoring?
Factoring is a form of financing in which a company immediately improves its liquidity by selling outstanding receivables. A service provider, a so-called "factor", purchases the company's receivables from, for example, service and trade transactions.
This means that outstanding invoice amounts are usually available immediately and long payment terms are avoided. Depending on the type and scope of the factoring arrangement, the respective provider also takes over dunning, debt collection, or the risk of payment default.
The factor requires, in addition to solid creditworthiness of the factoring client and especially their debtors, corresponding fees for their services. Providers fundamentally distinguish between two types of factoring: recourse and non-recourse.
Recourse and Non-Recourse Factoring
What Are Recourse and Non-Recourse Factoring?
In non-recourse factoring — the predominant type practised in Germany — the factor purchases the receivables and simultaneously assumes the full default risk. Through this "del credere protection", the client receives the assurance that all receivables will be settled securely and in full.
In recourse factoring, by contrast, the factor purchases the receivables but does not assume liability. This form of factoring, which is rather rare in Germany, therefore provides the client with no protection against payment default.
In contrast, non-recourse factoring involves a transfer of receivables with risk transfer. As a result, the corresponding receivables are removed from the company's balance sheet. If the liquidity is used to repay loans, the equity ratio increases. This can be advantageous, for example, during a credit assessment, as the equity ratio is an important indicator for banks when granting loans.
