International factoring is an ingenious and relatively simple concept. Factoring serves as export insurance. Factors, usually working for a factoring company, guarantee the import price of goods to the exporter. It is the exporter who hires the factor. The factor is totally responsible for the cash flow from the importer to the exporter. In essence, credit is outsourced to the factor company.
Factors serve exporters in several ways. First, they hire out local employees to deal with the importer. This means that foreign customs and languages are no longer an issue for the exporter. Second, the factor takes over the financial arrangements between exporter and importer. Third, in so doing, the factor investigates the local firm doing the importing, especially the financial soundness of the potential importer. Finally, the factor expedites collections from the importer, and is 100 percent responsible for all promised money. The factor pays if the importer cannot. Factors, in other words, guarantee all contracted sales.
Hiring a factor reduces risk and worry over international clients. Since many import contracts are billed after delivery, cash flow issues do arise, as do worries about the solvency or transparency of an import firm in an unfamiliar country and culture. All factoring is done by locals who know the local scene and how to communicate in the local language. Cash flow and collections move more speedily.
Factors are normally paid on commission. A factor's fee fluctuates with the amount of sales his patron does with a specific country. This is done through the factor forwarding up to 80 percent of the purchase price at the time the contract is signed. Once delivery is made, the factor forwards the remainder of the money, subtracting his fee. The factor is totally responsible for all financial dealings with the importer so that the exporter does not need to worry about cash flow. Thus, company budgets become more accurate.
The main effect of factoring is to smooth international sales. Mutual suspicion is eliminated by the factor, who has already paid much of the purchase price in advance. Ultimately, the factor lowers transaction costs. Factoring is, in essence, an insurance policy that varies from transaction to transaction.
Organizations such as the Export-Import Bank exist largely to insure exports and foreign investments. However, factoring has largely taken this function away from agencies such as this and placed it in private hands. Factoring goes beyond the traditional role of the Export-Import Bank in that, unlike the latter, it monitors the behavior and financial operations of the importer and retailers.