The history of the concept of factoring reaches back to ancient Rome, whose wealthy producers and merchants employed a mercantile agent or “factor” to manage the sale and delivery of their goods. Records show that such factors continued to be employed with increasing frequency throughout the Middle Ages.
During the period of European colonization beginning in the 16th century, the exporters of consumer goods often employed factors to increase sales.
This phenomenon became especially important in America in the 19th century when a rapidly growing population resulted in burgeoning demand for European-made goods, particularly textiles. In order to respond to demand promptly, it became necessary to maintain stocks of goods on hand.
At this time, factoring services generally consisted of:
In return for these services, the factor was paid a commission in the form of a percentage of the value of the goods sold, which he deducted from the payment made to the seller.
As the number of factors increased steadily, in time some of them became affluent enough to support exporters by extending credit to them against the goods sent on consignment.
Such credit was guaranteed by the right of the factor to reimburse himself from the value of the goods that were sold. This right was subsequently embodied in the law, which gave a factor the right to place a lien on a seller’s goods and the authority to retain the goods until he was repaid any sums of money that he had lent.
In the second half of the 19th century, the role of American factors changed substantially. Advances in communication and transportation no longer made it necessary for an exporter to send his goods to someone on consignment and instead, goods were sold directly to buyers by salesmen who were equipped with books and cases of samples. This development essentially eliminated exporters’ need for storage, marketing, and distribution services but they nevertheless remained in need of financing. The legal basis for these financial services had once been the factor’s selling goods and being reimbursed from the proceeds of the sale. By now however, the situation had changed and that traditional system no longer worked. The solution was for the exporter to assign to a factor the receivables from sales made directly to a buyer. Factoring as we know it today began as factors recognized the needs of their clients under changing economic conditions.
The creation of financing by assigning receivables was something that Europeans had been doing for centuries. Such assignments were attested to by copies of invoices, frequently without the buyer being notified. This practice became particularly widespread in London in the 1950s. The simplicity (and confidentiality) of the transaction made it quite attractive for firms that wanted to create an additional source of financing.
It would be a mistake to suppose that factors enjoyed the same degree of assurance as did bill of sale discounters. In fact, quite a few factors suffered serious financial losses when major vendors went bankrupt.
What’s more, situations in which buyers returned goods without any prior notification or deductions were made from receivables could put factors who lacked any protection in such cases in a difficult position.
Such experiences encouraged the emergence of a method in the 1960s in which receivables assignment was combined with the American model. In this hybrid method, factors accepted receivables on a total turnover basis. These transactions were undertaken on a recourse or non-recourse basis as circumstances dictated, however the buyer was always notified of the assignment. The result in other words was factoring as we know it today.
In Southeastern and Eastern Asia, the only payment guarantee and finance-creating instrument that existed was the letter of credit at least until the beginning of the 1980s. The development of factoring in America had clearly shown that the revolutionary advances in communication and transportation had made the letter of credit outmoded. With increasing demand fueled by competition, buyers no longer wanted to commit funds for goods that they had not received or had not a chance to examine. This situation started to become true for Asian Pacific exporters who wanted to increase their business volumes with European and American buyers. For this reason, the development of factoring in this part of the world followed a course that paralleled the rise in foreign trade transactions as a rule although FCI statistics show that domestic factoring was also increasing rapidly in the region at the same time as well.
Since the emergence of the modern concept of factoring in the 1960s, this financing instrument has registered tremendous growth and with the significant contributions of organizations like FCI it has become an essential element of trade nowadays.