Outstanding bills pose a significant challenge for businesses: they require more admin, and they can also strain cash flow and liquidity. One option for combating this problem is factoring.

This article will tell you what factoring is, which forms are available, and what it costs to sell accounts receivable (AR). We’ll also walk you through the potential risks and show you the alternatives you have to avoid late or open settlements.

What’s in this article?

• What is factoring?
  
• What are the different types of factoring?
  
• What are the costs involved in factoring?
  
• What are the risks of factoring for businesses?
  
• How businesses in Germany can utilize factoring
  
• What are the alternatives to factoring?
  

What is factoring?

Factoring is a funding instrument in which firms sell their outstanding AR to a factor. This provider could be a bank, a financial services provider, or a specialized receivables-finance firm. The factor pays the business the invoice amount, less a commission, and then collects the AR. The selling company thereby transfers its bad-debt risk to the provider and enjoys immediate access to cash. That said, the specifics of how this exposure is shared depend on the arrangement selected.

Factoring primarily serves businesses seeking short-term working capital. It is beneficial for small and medium-sized enterprises (SMEs) with limited reserves, or for firms that want to offer their customers long payment terms, which might entail settlement delays. Factoring is an attractive choice for organizations without an in-house finance team to manage their AR.

From a legal standpoint, these arrangements are primarily governed by the German Civil Code (BGB), particularly its provisions on the assignment of claims.

What are the different types of factoring?

In principle, factoring takes two forms—open and silent—with open arrangements making clients aware a third party assumes their payables. The factor communicates directly with customers to collect payment. While this could lead to faster settlement of outstanding AR, it can sometimes be received negatively. With silent factoring, on the other hand, the assignment of claims remains invisible to the company’s clients.

Businesses in Germany looking to utilize this have a variety of different models to choose from. These differ, in particular, in their service scope and the specific duties the factor assumes.

Nonrecourse factoring

In nonrecourse factoring—the most common structure—the provider prefinances the AR, assumes the risk of bad debt, and handles all AR management tasks. Using this service gives you immediate liquidity and takes all the administrative processes off your hands. Nonrecourse factoring, however, comes with higher fees.

Recourse factoring

In recourse factoring, the factor assumes no liability for bad debts, meaning the business keeps the exposure that its AR will remain unsettled. This structure is best suited to firms whose customers have a proven track record of paying. The costs involved tend to be lower in recourse than the above.

Maturity factoring

With maturity factoring, the provider merely takes charge of collecting the debt, rather than advancing funds against the AR immediately. The business doesn’t see any money until its customer has settled its balance due. As a result, the venture retains the risk of bad receivables. This type is suited to companies that want to reduce admin by outsourcing debt collection, and those that are not reliant on instant capital. Maturity factoring is also more affordable than nonrecourse.

In-house factoring

As the name suggests, with in-house factoring, tasks such as debtor management and dunning are kept in-house. Founders, startups, and SMEs often use this option if they manage their AR internally but want to benefit from advance funding. Reducing the level of service provided by the factoring company significantly lowers costs compared to other models.

What are the costs involved in factoring?

The costs involved fluctuate massively, depending on the structure and the provider selected. The following information, therefore, serves solely as a rough guide.

For nonrecourse factoring, expect a service fee of 0.5% to 5% of the invoice total. Add to that the interest for prefinancing your AR, usually around 3% to 6% per annum. The rate is generally set based on the period during which AR receives prefinanced. An AR of €100,000 could result in a provider fee of 1.5% and 6% interest. Assuming a funding period of one year, this would yield fees of €1,500 and €6,000, for a total cost of €7,500. In many cases, the full bill value does not reach the business. Generally, you will receive between 80% and 90% of the invoice amount upfront.

Other types of factoring charge lower fees because their service levels are lower.

Businesses need to carefully assess whether factoring represents the right choice, weighing the benefits of immediate liquidity against the associated costs. Several considerations influence this decision, including the amount outstanding, customer willingness to pay, and the financial targets in place. A thorough cost–benefit analysis, alongside an assessment of your overall economic health, remains a core part of deciding whether this approach is right for you.

What are the risks of factoring for businesses?

Although factoring offers an attractive financing option for many businesses, it also involves risks and requires careful consideration.

Customer perception

One risk of factoring is that it doesn’t always go over well with your customers. With open factoring, they receive notice that a third party assumes their debts. Customers can take this as a sign that you don’t trust them to pay. It also gives them the impression that your business is in financial difficulty and is relying on prompt payment.

Plus, assigning your AR to a third party could prompt a change in payment behavior: customers can sometimes delay settlement to a provider. Additionally, some might feel pressured to pay, which can negatively affect their relationship with the business.

GoBD compliance

When using factoring, organizations have to ensure compliance with the principles for the proper management and storage of books, records, and documents in electronic form (GoBD). All the relevant information, such as invoices, payments, and the assignment of AR to the factor, must be documented in full, in a traceable and auditable manner. In turn, businesses that sell their AR to a factoring company need to integrate the entire process into their existing accounts, in compliance with the GoBD.

Tax requirements

Businesses in Germany also have to consider the tax implications of factoring. It is imperative that they correctly calculate and remit value-added tax (VAT). In that respect, assigning AR to a provider is considered a service, meaning it is usually subject to VAT. Enterprises must record both the factoring fees and the VAT accurately in their books. Companies that make mistakes here can find themselves in arrears with the tax office.

Integration into accounting systems

Integrating factoring into existing billing and enterprise resource planning (ERP) systems can introduce challenges. Accounting systems typically manage AR internally, so transferring receivables to a provider often requires adjustments that support accurate transaction processing and payment allocation. Pending workflows for managing outstanding items and monitoring settlements must also integrate smoothly into the current setup.

Poor or incorrect integration could result in administrative errors, such as double payments, incorrectly allocated sums, or delays in posting settlements. A lack of effective communication between internal departments and external providers can lead to misunderstandings and additional time spent on admin.

How businesses in Germany can utilize factoring

Factoring supports a wide range of industries and business models through flexible use cases. In sectors where corporations face long production cycles, large order values, or limited liquidity leeway, this approach often becomes a particularly valuable source of support.

Factoring in the manufacturing industry

In the manufacturing industry, extended production cycles and high upfront costs often require prefinancing. Prolonged payment terms force companies to wait months for buyers to settle invoices, placing significant strain on operations and constraining working capital. These delays can complicate financing for materials, wages, and other operating expenses. By selling their AR to a factor, businesses can secure access to cash instantly and maintain smooth production.

Factoring in wholesaling

Wholesaling is another sector where factoring can help businesses avoid liquidity shortages. Wholesale companies frequently have long-term relationships with their clients, who place large-volume orders. They therefore usually agree to due dates of 30 to 90 days or more. By using receivables finance, wholesalers can shore up their cash position without waiting for customers to pay.

Factoring and long payment terms

Regardless of the industry, factoring is an obvious financing option for organizations with long payment terms. On an IT project, for instance, a business might agree that 80% of the bill total is due upon delivery, and the remaining 20% upon final acceptance. Here, this approach would allow the IT service provider to receive 80% of the invoice value immediately. They can then cover their personnel and development costs without running into financial difficulties.

What are the alternatives to factoring?

While factoring can improve your cash position, there are other solutions for avoiding late payments and shoring up liquidity. Across the extended term, a more cost-effective alternative is to refine your AR management, for example, and to utilize modern ways to accept and reconcile funds. In doing so, businesses maintain complete control over their AR and avoid potential reputational damage.

Professional billing is key to ensuring a reliable stream of payments. Stripe Invoicing can simplify your debtor accounting. You can generate, modify, and send professional invoices in the blink of an eye. Stripe automatically tracks invoice status, sends payment reminders, and processes refunds so that you can keep your cash flow under control. Plus, AI-assisted dunning tools help you identify late settlements early so you can target them for collection.

Stripe Billing lets you manage recurring invoices and subscriptions. It also lets you bill for usage-based models and tailored contracts. Stripe can automatically retry failed payments for you. With Smart Retries, you can deploy an intelligent algorithm that retries the transaction at times when it is more likely to succeed.

To increase the likelihood of reliable payments, make the checkout process as straightforward as possible for your clients. Stripe Payments gives you access to more than 125 ways to pay and more than 130 currencies. You can offer your customers a range of prepayment and real-time options, set up flexible processes for paydown and outstanding payments, and more.