Factoring or Discounting of invoices

Factoring: An Overview

When a company accumulates numerous accounts receivable, such as invoices or promissory notes, it may turn to factoring, also known as invoice factoring or invoice discounting.

Factoring becomes a highly viable option for a company in need of liquidity to continue normal operations. By meeting specific requirements, the company can quickly obtain funds equivalent to the unpaid invoices. In exchange for signing a contract and paying a commission, companies engaged in factoring finance the value of the invoices and handle their collection from the debtor.

Legal Concept of Factoring

In Costa Rica, companies involved in factoring are organized under the Costa Rican Chamber of Factoring Companies (CCEF). The system is defined as “a financial product that involves advancing the payment of an accounts receivable, which is assigned to an individual or legal entity responsible for managing and collecting said document.”

Factoring can be used to convert credit sales into cash sales, encompassing invoices, promissory notes, bills of exchange, contracts, and any other document supporting an accounts receivable owed by a customer. Importantly, once the contract is formed, the debtor must be notified of the assignment of the invoices to the factor.

Types of Factoring

1. Domestic Factoring: For companies operating in Costa Rica, establishing factoring with the Factor through a contract and payment of a commission. Once the contract is established, the debtor is notified, and from that moment, they must pay the Factor directly.
2. International Factoring: This includes export factoring when the client and the factor are in the same country while the debtor resides abroad, and import factoring when the client resides abroad, and both the factor and the debtor are in the same country.

Key Figures in Factoring

1. Client: The company requesting the service, needing capital, with numerous unpaid invoices for services or products.
2. Factor: The entity providing factoring services, financing the money from the invoices. Factors can include banks, solidarity associations, individuals, legal entities, or general financial entities.
3. Debtor: An individual or organization owing money to the client.

Requirements for Factoring

The company provides a profile specifying its activities and major clients. The client provides the factor with diverse information, including history, products or services offered, general and legal background (Letter of Credit Application), recent financial statements, bank account statements, legal personality, Articles of Incorporation, and ID of the company’s representatives. The client submits the invoices for financing for review, ensuring they meet specified requirements. If the client meets the legal and financial requirements, both parties establish a contract outlining the terms of service, agreeing on the payment of a commission to the factor, who will provide funds for the invoices and collect from the debtor.

Characteristics of Invoices Used in Factoring

For a client to use an invoice in factoring, it must meet criteria such as being well-digitized, legible, and meeting other characteristics specified in Article 460 of the Commercial Code of Costa Rica. These include bearing the name and signature of the buyer, being validly transferable through a cession contract.

Scope of the Factoring Contract

When the client and the factor agree on factoring, they sign a contract that stipulates all aspects of the business. The factoring contract, also known as the “invoice assignment contract”:

Includes the names of all parties. Establishes the rights and obligations of those involved. Details the commission the factor will receive for managing unpaid debts and collecting them. Specifies that the factor will handle the accounting of the invoices that the debtor pays or not (accounts receivable). Is issued for a specific period, leaving open the possibility of extension or signing indefinitely. Specifies actions to be taken by the factor if the debtor does not pay, such as the client assuming the debts or the factor taking legal action. May be in the form of a public deed for greater validity, depending on the debtor’s rules for accepting the invoice assignment. The invoice to be assigned must be endorsed, with the client doing so directly for individuals or the legal representative of the company for legal entities. Once established, the debtor is notified to pay debts directly to the factor.

Benefits and Risks of Using Factoring

• Risks of Factoring:
  • The figure of factoring in Costa Rica lacks legal regulation.
  • Risk of the debtor not meeting payments or being insolvent, leading to the factor incurring administrative costs for collection.
  • If the debtor does not pay, the client may need to resume payments to the factor, as specified in the factoring contract.
  • Risk of falsified invoices, requiring the factor to allocate resources to thoroughly investigate their validity.
• 10 Benefits of Using Factoring as a Capital Source:
  • Quick receipt of funds, similar to receiving cash for credit invoices.
  • Elimination of the need to request a bank loan, which can be time-consuming and more costly in terms of administrative expenses and interest.
  • Additional savings by avoiding the management of collections.
  • Immediate availability of funds for investment in various areas to grow the business.
  • Accessibility to factoring for both large and small to medium-sized enterprises.
  • The type of collateral used in factoring does not encumber the assets of the client company.
  • Efficient management of outstanding accounts by an external and experienced entity.
  • The factor, with expertise in collections, becomes a role model or commercial mentor for the client.
  • Facilitation of early acquisition of foreign exchange for importing companies to mitigate the risk of currency fluctuations.
  • The factor takes care of the respective accounting tasks.