Factoring in its various forms continues to be a very popular instrument for optimizing net working capital, whether in the context of regular bilateral factoring agreements, reverse factoring or structured transactions using special purpose vehicles in asset-backed securities or asset-backed commercial paper transactions. Coupled with the ongoing pandemic situation, the current geopolitical state of affairs is causing dislocations in globally aligned supply chains. In this context, supply chain financing – and therefore factoring – is particularly important in Treasury for managing companies in times of uncertainty. Factoring is an excellent way of easing a liquidity crunch by selling and prefinancing customer receivables. 

But there are a few stumbling blocks to avoid when it comes to signing a new factoring agreement. In addition, existing agreements should also be reviewed to determine whether they have been implemented correctly from a process point of view. After all, not only accounting issues can usually only be solved across departments. Also, implementing the contractual agreement usually requires close cooperation between Treasury, Accounting and Legal. 

Of particular importance in this context is the transfer of the default or credit risk. From an accounting perspective, transfer of the default risk is a fundamental prerequisite for the derecognition of receivables. Consequently, the improvement in balance sheet ratios that is often sought can only be achieved if at least part of the risk is transferred. Accordingly, the agreements frequently contain risk transfer clauses. In addition, there is an inherent incentive for banks and factoring companies to keep their risk assumption as low as possible. As a consequence, part of the default risk often remains with the transferring company via reserve accounts, guarantees and strict default definitions.

Typically, a default is assumed after a fixed period has passed since became overdue (notional default event). At the same time, the actual default of a sold receivable is usually also borne by the buyer. In this case, the company's internal credit management guidelines often become part of the contract. 

For such a complex contractual relationship to be implemented in terms of processes, a high degree of transparency is imperative as a first step. Actual events of default can only be asserted against the factor insofar as they are identifiable. For this reason, stringent receivables management is required, which can also be tracked in detail in the accounting system. This is because, typically, the data from the accounting department is used for settling any factoring agreements. In addition, the processes for the sale of receivables must be reviewed to determine whether reversal is also provided for. In the event of a default event, it must be possible to correctly unwind an already prefinanced receivable so that the seller and buyer of the receivable actually realize the agreed risk sharing. The same applies to fictitious bad debt losses. Where payments are received at a later date, the buyer of the receivable is generally entitled to them.

For these reasons, establishing a process for the sale of receivables that is as automated as possible is a complex task. The first step is to translate the legal contract correctly into individual process steps. These need to ensure that, on the one hand, the recognition in the balance sheet is correct and, on the other hand, that the payment flows are also settled correctly. To achieve this, it is essential to have a transparent receivables management system that is closely integrated with accounting.

If you are looking for support in negotiating new factoring agreements or in optimizing your processes for handling sold receivables, please do not hesitate to contact us.

Source: KPMG Corporate Treasury News, Edition 121, May 2022
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Stefan Barth, Senior Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG