Mitigating Techniques for Commercial Risk/Factoring-Transference

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Globe for WikiEducator.jpg Unit 3.5- Mitigating Techniques for Commercial Risk 

Introduction | Commercial Banks | Loans | Letter of Credit | Draft Collection | Accounts Receivable | Governments | Factoring | Forfaiting | Banker's Acceptances | Credit Insurance | Summary | Resources | Activities | Assessment


Factoring can be described as the outsourcing of credit and collections. In other words, a seller pays another company, a factor, to collect payments from a buyer. The factor buys the accounts receivable--product or services that the buyer wants-- and pays the seller directly. The factor owns the receivables and goes after the buyer if the buyer does not pay the factor.

Its use in international trade goes back centuries. Cross-border factoring differs from domestic factoring in that the factor does not purchase the receivables unless and until they become past due.

When a factor guarantees payment and a seller needs the payment before it is due, the seller can borrow from the factor at some cost to the seller. The factor makes all credit decisions for the seller and collects all receivables from approved buyers. Unless the reason for non-payment is a dispute between the seller and buyer, the factor pays 100% of past-due receivables. Factors allow sellers to pick the customers they want to include, though not individual invoices. A rule of thumb is that factoring costs about twice as much as credit insurance.

A limitation on factoring is that it only exists in countries with laws that support the buying and selling of receivables--common in developed countries, but not emerging markets. If cost and range of risk coverage are issues, it is usually more satisfactory to use a letter of credit or export credit insurance. Most factors are "niche" players, usually concentrating in select regions of the world. There are certain industries, such as textiles and clothing, where factoring is considered a part of doing business.

The problems factoring presents to most companies are that most factors don't cover the riskiest countries and the service may be cost prohibitive for companies with tight profit margins.