Taking the Mystery out of Factoring
Sep 20
Marc
Accounting Process, Blog, Finance
What Is Factoring?
Factoring is when you sell your accounts receivables (unpaid/outstanding sale invoices) to a finance company so you have working capital now instead of waiting.
Sometimes it is also called Discounting, Debtor Finance or Supplier Finance.
In short it’s like monetizing your “Money Owed To Me” list by selling it. The buyer/lender gets the invoices at a discount because they have risk of some people not paying them and they have labour and collection expenses to cover. Factor Co’s will buy/lend up to 85-90% of the value of your outstanding invoices. No doubt as you get bigger and if your customers are better credits you get to keep more of the invoice value.
What Is So Special About Factoring & SaaS?
There are some unique advantages to Software-as-a-Service, especially with Saasu.com in the factoring world -
- Up To Date - Saasu.com users are in a very good position to provide live access to Factoring companies should they wish to finance or sell their receivables.
- Reduced Risk Means More Cash - Factoring Finance Companies can get read only access directly into their client’s records with their permission or even use us to up load invoices via our API from other older style software packages allowing online reporting back to their customers.
- Easy To Setup - Business owners looking to get quotes from Factors can provide the Factor with a temporary shadow ledger user access in minutes.
Rationale & Useful Resources
The logistics of how Factoring works is different with each Factoring Co. you deal with.
Factoring can be very handy but it does come with mixed emotions as you lose some control over customer relationships. In many cases the Factoring Co’s issue invoices to your customers which leads to risk that customers can start to receive duplicate information if the data between you and you Factor Co. isn’t matching. This is a problem for accounting software which isn’t live like an online SaaS accounting service is.
With Saasu you are both looking at the same data set or using the API to keep the Factor’s records up to date.
If you do need to use Factoring then consider that the larger reputable banks and large finance companies like GE Commercial Finance have retail reputation to maintain so they aren’t as likely to do the wrong thing with your precious customers. Many investment banks are getting into this area because these debts can be securitised in receivable Asset Backed Securities. Barclays is getting involved online which is great because it will bring ease and technical credibility to the Factoring Industry as bigger players step up and improve access.
Credit officers in the banking and finance industry may be able to provide more finance and sometimes at better rates when live financial accounting information is available. This particularly suits the Factoring industry. Out of date accounting files are a problem when it comes to establishing exactly what is owed and when to a business. Accuracy of records that the Factor has is another problem they face that you will no doubt pay for if the information you give them isn’t accurate. Giving them live access can help with this issue.
The Federation of international Trade associations has a good article on International Factoring for those in the import/export business.
Institutes for Factors and Discounters
UK - Asset Based Finance Association (ABFA)
AU - Institute for Factors and Discounters of Australia and New Zealand Inc.
INTL - International Factors Group
I have personally been involved in running and operating four factoring facilities and thought some of my experience might be interesting for others.
Issues to consider are:
Disclosed vs Non Disclosed
there are two types of factoring facilities - disclosed and non disclosed. Disclosed is when the factoring company sends the invoice to your customer and your customer knows the debt is factored. The factoring company also phones your customer and has direct contact with them. The other is non disclosed - you send your invoice to your customer and the bank, then the bank funds you 80% to 90% of the invoice value. When your customer pays the bank, the bank releases the balance owed to you.
Concentration Limits:
The next point to consider is concentration ratios. Banks will often say that once a particular debtor reaches 30% of the factored amounts, they will stop funding you on that particular debtor. This can be critical in a cash flow critical business - ie recruitment firms running contractor books. You must have spare cash or excess working capital to cover this type of situation. The concentration limits will change once that particular customer pays you.
90 Day Funding Issue:
If a particular debtor falls into 90 days DSO plus, some discount finance companies will no longer forward you funds on that debtor. It is very important to ensure your debts are collected quickly. This has the ability to severely restrict your ability to access funds.
Intercompany Transactions:
If you have companies within your group that engage in commercial transactions with each other, most of the banks will not factor or pay you money on those transactions. This is a very key point to consider as you are effectively removing access to cash flow if you have intercompany or intergroup transactions.
Offshore Clients:
Some of the banks won’t factor international transactions. If you deal with a lot of offshore clients, this could create cash flow issues for your business as you will need to find other means of cash to fund these transactions.
Facility Limits:
Most of the large players (St George, Commonwealth Bank, Westpac etc) will set an upper limit for your facility. If your business momentum grows quickly, you may find yourself reaching the limit quite quickly. This can mean re negotiating and re applying for a new facility limit - a process that is time consuming and costly as you would need to go through the whole credit approval process again.
GE Finance actually offer a product that is slightly different and in my opinion, probably superior to the mainstream providers. They offer a service that is similar to Commercial Bills. They set an amount that you can draw down upon to fund your business - the liability to the bank is then reduced as you issue invoices and receive funds from the customer. It is a bit like an overdraft - rebadged and rebranded in a different way.
The mainstream providers will insist that you invoice your customer first, then access the funds. GE is slightly different in that you can draw down and then invoice your customers.
Administration of Facility:
You must stay on top of your game if you are running one of these facilities. They are complex in nature and time consuming. A business running a debtor book of approximately $8m should almost have a full time person collecting cash and maintaining this type of facility. The banks have very strict compliance rules and expect to have your accounts audited every 2 to 3 months. This is where a real time accounting system like Saasu can help. Your banker could have their own log in code to view your financial performance at their own leisure - this saves you time and resources as the bank won’t need to spend as much time on site with you.
You must ensure payments, receipts etc are recorded in real time when running a discount finance facility.
Cost Involved:
A typical interest rate in todays value is around 10.65% less 1.5% discount - cost is about 9.1%pa - depending on your risk profile. You will also pay a montly admin fee around $2000 to $5,000.
The interest charge is similar to an overdraft (overdrafts don’t have the headaches but often are required to be secured with property).
Under discount financing arrangements, the debtor book secures the debt. If you have a first class portfolio of blue chip clients, then you wont have any trouble accessing discount financing.
In my opinion, if you have access to an overdraft facility - use this instead of discount financing. If you use discount financing, you must ensure that you have spare working capital to cover situations like:
- Concentration limits being involked
- Slow paying customers that fall past 90 days
- Lack of technically experienced resources in your
Your experience and operational efficiency using discount financing will depend on the requirements of the individual bank.
Enage with each party you are talking to at a deep level. Don’t just speak with the Business Development Manager trying to sell you a financial solution - insist on speaking to the folks that actually operate the facility and get a deep understanding for the administrative requirements. This is key in the whole process.
You may need to adjust the way you do things to meet the reporting requirements of the bank. They will have specific requirements around file formats, your accounting system will need to be re programmed to cater for this - otherwise you will be on a crash course from the beginning.
I hope these comments have helped and would welcome any calls or emails if people need further help with Discount Financing.
Comment by Martyn Dominy — October 18, 2007 @ 10:35 pm
Martyn, I think your depth of experience shows in this field so I think we should post this in it’s own entry. Thanks!
Comment by admin — October 19, 2007 @ 10:07 pm