Many start-ups and SMEs continue to underestimate the financial consequences of bad debts and payment delays and do not implement targeted measures. In a serious of blog entries, we answer the most important FAQs on this topic.

Is factoring worthwhile as a possibility to prevent payment defaults?

Factoring, i.e. the sale of receivables to a special service provider – the factor – primarily enables a company to get its money faster. This is because the factor pays out a large part of the money, around 85-90%, just a few days after the sale. Depending on the scope of services provided, he charges a fee of between 0.75% and 3% of the amount outstanding, plus interest on the amount paid out prematurely.

This means that the selling company already has a large part of the receivable shortly after invoicing. This improves the liquidity considerably. It is also possible to settle your own liabilities by taking advantage of a discount, which absorbs some of the costs.

However, factoring usually does not offer comprehensive protection against payment defaults, because a factor, for its part, checks the creditworthiness of the companies whose receivables it buys. And usually only receivables from companies with a good credit rating are bought. In the at least potential problem cases, one remains stuck and has to become active oneself, e.g. check the creditworthiness, monitor the receipt of payment, send reminders, etc. Factoring can therefore be at best a component of comprehensive receivables management.

Practical note: In order to prevent your own bottlenecks in the event of payment delays or even defaults, you should try to build up a liquidity reserve. This can be done, for example, by depositing a certain percentage of each order, e.g. 3-5%, in a separate account.

It is not possible to say in general terms how high the liquidity reserve should be. But an estimation could be:

  • 3-5 times the average order volume or
  • the average monthly cost volume without depreciation

Example 1

On average, a company achieves orders in the amount of 5,000 €. Then the liquidity reserve should amount to about 15,000-25,000 €.

Example 2

If the average cost per month is €30,000, one should try to build up a liquidity reserve of about this amount in order to be able to meet all obligations even without payments.