Factoring, known in Brazil as Fomento Mercantil, is a service activity that includes ongoing advisory work on credit, risk, accounting, inventory, and working capital management, in tandem with the irrevocable purchase of credit rights, in the form of receivables that arise from the sale of goods or services with maturities ranging from 30 to 300 days.
The factoring company assumes the credit risk associated with the negotiable instruments, which has remained historically low for the last 10 years due to the severe penalties existing for defaulted credits. Factoring must be based on commercial sales and is governed by Brazil‘s Civil Code. It can be conducted only with legal persons or enterprises and not with individuals.
The most common accounts receivable are duplicatas (commercial invoices), which account for almost 90 percent of all factoring receivables. Others are checks, bills of exchange, bills of lading, warrants, promissory notes, and post-dated checks (which can be issued to cover mercantile sales, as in commonplace in Brazil).
There are over 700 known factoring companies in Brazil, which provide services to more than 65,000 small and medium enterprises. Eighty percent of these enterprises belong to the industrial sector, with a monthly turnover of around US$10 billion (R$27 billion) as creditor rights resulting from mercantile sales, representing approximately 6 percent of all domestic sources of financing.
Factoring companies had more than 6,000 employees and were estimated to provide another 710,000 indirect employment opportunities. Thus, factoring is a sizeable industry in Brazil and an important source of finance for a number of firms. Overall delinquency ratio for receivables is estimated to be around 3.8 percent across all sectors.
Factoring is an important alternative to the banking sector for the financing of small and medium enterprises. Given difficulties of entry into the formal banking system, factoring companies have found an important market niche.
Factoring companies work at a much smaller scale than banks, in close association with their creditor. Accounts receivables are already expected cash flows and, thus, a company eliminates its client’s business risks through factoring.
Here’s a brief video on how basic factoring works … Enjoy!