The X factor
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Factoring and invoice
discounting are playing an increasingly major role in trade and asset-based financing of businesses For assignment of a company's receivables, a factor would advance up to 80% of the money owed by debtors. Financing charges would include interest at 1-2.5% over base rate on the advance, and a fee of 1-1.5% to deal with administration and management of the sales ledger, as well as providing indemnity insurance.
Most agreements are for 12 months and there are penalties for early cancellation. You often have to give three months' written notice before the expiry date to avoid a penalty.
The factor would expect to earn a minimum fee based on fee, percentage and turnover. This fee would be payable even if the turnover was lower than expected. It is important to disclose all possible variables that could affect the turnover so that the minimum fee is set at an acceptable level.
By a method called recourse, the factor can recover the advance from the client if it was not successful in collecting the debt. Non-recourse has the advantage of receiving the money from the factor without having to pay it back if the customer does not pay. The fee rate would be lower if non-recourse cover is not needed.
Factoring only works where there is clear evidence of delivery of goods or service. For example, a service of a haulier is factorable while the services of an accountant are not. In some businesses where goods and services are provided, it is quite possible that the factor will want to exclude the services. You therefore need to find out what will be excluded.
Factors are entitled to be choosy They are likely to exclude: • Debtors over 90 days; • Debtors representing more than a certain percentage of sales ledger, usually 25%; • Debtors relating to services; • Export debtors; unless special arrange ments exist.
• Debtors without approved credit limits a certain period; usually These restrictions can reduce the funds brought in by factoring. You may wish to exclude from the factoring arrangement customers who usually pay quickly because the cost of factoring those debtors may not be worth incurring.
Factoring also means handing over the credit control work to the factor. While this can be very useful to a company with poor credit control procedures, it can be a waste of money where a company's credit control procedures are good.
You might want to consider invoice discounting instead. And a client needs to satisfy himself that the factor's staff will be competent enough to deal with the customers.
You must be aware of the financial status of the factor. It must not be overlooked that while full value of the debtors is assigned to the factor, only 70-80% will have been advanced. This means you are risking 20-30% of the debtors' value if the factor goes into liquida
tion. Remember that your bank overdraft is usually secured by a debenture with fixed and floating charge over the company's assets, so assigning debtors to a factor reduces the available security value. You should review the arrangements with the bank. Usually the value attached to the debtors by the banks is more like 205O! of the face value. This means that it would still be beneficial to factor debtors, even if the overdraft facility is reduced.
Factoring or invoice discounting are ideal forms of financing for growth. As sales increase, you are able to cash in up to 80% of your invoices in a matter of days. With availability of credit from suppliers, the business would be cash-positive. This would enable negotiation of early settlement discounts or buying more equipment to satisfy contracts. These improvements in cashflow and profitability should be compared with the cost of the factoring fee.
The credit limits you set your customers could be an area of disagreement as the factor will set limits for each customer and will usually advance up to 80% of these limits. While credit limits curb the risk of bad debts, they could also hinder business with valued customers. Some factors will advance the money even if credit limits are exceeded, but they would only provide baddebt cover up to the percentage of the credit limit.
Not all factors handle export debtors. If the client is exporting you would need to make special arrangements for this. And factoring of export debtors is only possible with US and European countries.
Factors can provide various helpful statistical reports such as turnover by customer, average debtor days by customer and for the business. Find out what information can be obtained—and if you have to pay for it.
Factors will pay commission to introducers: you should negotiate this even if it is to be credited against the fees.
r by Subhash V Thakrar The author is a Partner with the City accounting jinn Blackstone Franks & Ca