Factoring: a popular banking tool
So, how does factoring work? In simple terms: when a company sends an invoice to a customer, it “sells” that raised invoice to the factoring company – in this case, a bank. The bank pays the invoice in advance. When the company receives the payment from the customer, it transfers the relevant sum back to the bank.
However, factoring carries a certain risk. If a company finds that for which it has already received advance payment from the bank, not only are they faced with bad debt, they can also find themselves unable to pay back the bank. The solution is insurance.
Building trust in factoring with trade credit insurance
What does this look like in practice? Let’s say a seller provides a product to a buyer and sends its invoice both to the customer and to a factoring company, hoping to receive a financing of approximately 85% of the value of the invoice. However, if the buyer has a below-average credit profile, the factoring company may refuse to advance the payment. This is where TCI comes in. If the seller is covered by TCI, the factoring company enjoys more security and is more likely to agree to the payment. As a result, the seller gets both the advance financing that smooths out its cash flow and the security of TCI coverage, while the buyer gets the benefit of appropriate credit to conduct business.
While supply chain businesses are the most common users, any company that uses factoring can benefit from TCI. It provides a valuable cushion for extra security and significantly boosts the quality of financing relationships. Factoring and TCI are particularly important when doing business with new customers where there is no track record of payment. And it is critical when dealing with foreign customers, for whom credit information is often limited.
Reducing risk and boosting business
Factoring can be an extremely useful tool for companies on both sides of a buy-sell transaction, but it is not without certain risks. The best and easiest way to mitigate that risk for all concerned is by taking out the appropriate trade credit insurance with an insurer that has solid experience working with banks. So, next time you think about transferring an invoice to the bank for factoring, consider contacting Allianz Trade. We can help you make that service safer and ensure that everyone does business with confidence.