Arithmeticof factoring
Page 68
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by Michael Mills
ACTORING provides funds for torking capital. Whether these ,Inds are enough to meet all forking capital requirements as company grows depends enti3Iy on the nature of the busiess, the profit margins on rhich it is working, and its rate f growth.
Factors normally pay an initial ercentage against invoices up ) a maximum of 75 per cent and le balance, less charges, is paid then the invoice itself is paid by le customer.
Thus funds are still needed to teet the balance of say 25 per ant though part of this may ome from the margin of profit n the sales.
As sales grow, the amount eeded to finance 25 per cent of ebtors will also grow. Take as n example the company whose nly asset is debtors. If the Jrnover of that company was 50,000, the debtors would robably be about £10,000 and ictoring with an initial percenige payment of 75 per cent rould release about £7,500 cash ) be used in the business.
If these funds were used to uild the turnover up four times ) £200,000 and if the debtors 'crease pro rata they would and at £40,000 against which 30,000 will have been put up by le factoring company. On the basis that the company has no other source of funds, the £7,500 original cash would now have been used up in financing that part of the increase in the debtors not provided by factoring (that is, 25 per cent of £30,000 increase in debtors).
In practice, of course, the cornpany will be operating at a profit. Let us suppose that its net profit margin is ten per cent, and that with the help of factoring the company's turnover grows rapidly, so that in its first year after the beginning of factoring it makes £200,000 turnover for a profit of £20,000. After providing for tax at 40 per cent this leaves an additional £12,000 working capital. This, in turn, will allow the company to grow by an increase in debtors so that the 25 per cent not financed out of factoring is equal to £12,000 — that is, maintaining the previous ratios, a further £48,000 debtors representing new sales of £240,000 per annum for a total turnover of £440,000. Rapid growth indeed!
Obviously this example is an over-simplification, but the point is made.
The client sends his invoices to his factor daily, weekly or monthly. The initial percentage payment due is calculated for each such schedule of invoices.
The factor mails the invoices to the client's customers accompanied by a notice stating that the invoices have been assigned and that payment should be made only to the factor. The transactions represented by these invoices aie then posted to the sales ledger which is kept for each client.
When payment is made by the customer, the client receives the difference between the initial payment and the nett invoice value, less the factors charges.
At the end of each month, the client will receive: (a) a statement of his account with the factor; (b) a debtors age analysis.
In addition, the client is notified when payments have been received from customers, and is given advance warning when invoices are starting to run overdue.