What is International Factoring?

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2 What is International Factoring? Factoring is when a third-party firm, or factor, buys a business accounts receivable or specific invoices - giving the business a cash advance based on those unpaid bills. This cash advance is typically the face value of the invoice minus a discount which is usually in the range of 2-6%. The third party then takes over collecting the amount owed. Some factoring companies will initially pay 75-80% of the face value immediately and will pay the rest (less the discount) when the invoice is paid; others have varying terms which will have an impact on how much is charged for the service. The process allows businesses to access cash faster than waiting 30 or 60 days to collect payment from customers by invoicing. Because of this it is a form of financing often used by small and medium-sized companies to maintain cash flow and therefore survival. Also, because it is the business clients that need to be credit worthy rather than the business, factoring could be the answer for those companies who need immediate access to cash but don t qualify for a loan. Depending on what the business needs, factoring can be a complete package that combines working capital financing, credit risk protection, accounts receivable bookkeeping and collection services but companies can pick and choose what they need rather than having to pay for everything. When factoring takes place between countries, this is known as international factoring. Internationally, bank rates are higher around the world at the moment than in the UK, meaning raising finance can be costly for international businesses. The base rate in the UK has stood at 0.5% since March a record low and this presents a good opportunity for overseas companies. They can factor their outstanding invoices or debts to third parties or investors in the UK who won t be making much money on their savings or investments due to the low interest rate environment and will be looking for new opportunities to make money. International factoring started in the 1960s with European countries as the early pioneers. It is now widely accepted as being a key solution to solving the financial needs of small and medium-sized businesses and exporters. It has the support of government bodies and central banks throughout the world and an increasing number of large exporters are using international factoring as well.

3 How does it work? Different customs, currency systems, laws and languages still create barriers to trade in a world where sophisticated computer technology allows orders abroad to be placed within seconds. One of the greatest problems facing exporters is the increasing insistence by importers that trade be conducted on open account terms, meaning that payment is received many weeks or even months after delivery of goods or services. Many organisations find that giving buyers credit in this way can cause cash flow problems, which can be made worse if the importer delays payment beyond originally-agreed terms or makes no payment at all because of financial failure. Cash flow problems can cause businesses to go bust. International factoring provides a solution, regardless of whether the exporter is a small organisation or a major corporation. The role of the factor is to collect money owed from abroad by approaching importers in their own country, in the locally accepted manner and without a language barrier. As a result, distances and cultural differences cease to be a problem. A factor can also provide exporters with 100% protection against the importer s inability to pay. The benefits of export factoring have proved to be attractive to international traders. It is now seen as an excellent alternative to other forms of trade finance and the role of the letter of credit is gradually diminishing as a consequence. The prospects for international factoring can be seen as favourable in all countries developing and economically established. In the future though, the real challenge for factoring companies will be to maintain their flexibility so that they can react quickly to changing market circumstances.

4 What are the benefits of factoring? Time savings: Factoring can save time and effort that would otherwise be spent on chasing money from customers. That effort can instead be used to develop the business, to grow sales or focus on marketing and client development. Growing the business: The instant cash can be used to generate growth. The cash could provide the opportunity for a new salesperson to be appointed, for example, new advertising or even a piece of equipment to improve production. Collateral not required: Unlike traditional bank loans, factoring doesn t require you to risk your home or other property as collateral. Qualify for more funding: Factoring firms will typically give a cash advance on up to 80% of your receivables, which may be more than you would be able to get from a bank. Access to cash quickly in most cases within 24 hours. No minimum Pick and choose how many invoices you want to submit for factoring. No long term contracts meaning greater flexibility No cash use restriction: Unlike a bank loan or line of credit, you can use cash funded to you for any purpose. Company financials not required: Factoring is not determined by the state your company s financial reports and it s not necessary to submit accounts. New and non-bankable businesses welcome factoring helps businesses with little or no credit history. What are the disadvantages? The most common thing small business owners don t know about factoring is that their customers are notified when a factor takes the receivables over. That may alert them to potential cash flow trouble or lead them to believe a company is in danger of going bust. Once you accept cash for your receivables, you give up a measure of control. For example, the factoring company could deny your ability to do business with a particular customer because of its poor credit history or rating.

5 Country Focus: Brazil Brazil holds the seventh largest GDP in the world and is the fifth biggest in terms of extension and of population, with over 195 million inhabitants. It is also the main economy in Latin America, representing 40% of the total activity. Brazil along with Russia, India and China, collectively known as BRIC has been long-hailed as one of the biggest emerging global economies. In 2013, Brazil s economy grew 2.28% and its gross domestic product (GDP) reached $2.243 trillion, due in large part to the country s reliance on small and medium enterprises (SMEs) for both jobs and growth. Of the total number of businesses in Brazil, 98% are SMEs that provide 96% of the country s employment opportunities, according to Hanover Research, a global information and research firm. The capital market is an important instrument in financing companies growth in Brazil, especially in the case of large companies. The Brazilian central bank s monetary policy committee, known as Copom, unanimously decided to keep its benchmark Selic rate at 11% in September, as had been widely expected by both the market and analysts. In a statement, the central bank said it evaluated the economic and inflation outlook to make its decision, but removed the phrase at this moment, which appeared in previous months statements. Analysts have interpreted this omission as a sign that policymakers will leave rates steady for some time. The IPO market in Brazil is booming, with 21 IPOs in the Brazilian market raising approximately BRL 27 billion (with a median figure of BRL 700 million), in the two years leading to However, the Brazilian Chamber has identified that there is still unexploited potential in the Brazilian capital markets relationship with such companies. Indeed, a higher Brazilian base rate has inspired fund managers, asset managers and investors who historically prioritise allocation into fixed income to seek investment alternatives. Santander, a United Kingdom bank wholly owned by the Spanish Santander Group, recently ran a programme aimed at connecting British SMEs with Brazilian companies. Brazil was an obvious destination for the Breakthrough programme s inaugural trade mission, according to John Williams, head of breakthrough at Santander. The country has long been considered a rising economic superpower with its vast natural resources, booming population, massive infrastructural requirements and a growing desire for luxury consumer goods, he said. Combine these factors with substantial economic growth, a benign political and business environment and a bundle of international trade agreements and you have the perfect export market for ambitious UK-based businesses. This Brazilian boom has resulted in a large number of SMEs launching many of whom are likely to be experiencing short-term cash flow problems. This could well pave the way for Brazilian companies to consider international factoring as a way of alleviating this issue, while developing and growing their businesses. In an article for WorldWatchReport.com, Brasilfactors a joint venture company launched by Fimbank along with the IFC and Bicbanco said: Brazilian corporates, especially SMEs, still suffer from a funding gap, and it is recognized that factoring has been providing much needed support for these companies, being capable of reaching more than 150 thousand clients throughout the large Brazilian territory. International factoring remains almost unknown in the market with a turnover volume of USD74 million in 2012, which is well below the country potential, and just 0.1 per cent of total factoring volume. Exicon Export and import Consultoria S/A has been the only player promoting international factoring, but during 2012 BRASILFACTORS and Nova SRM have also commenced international factoring operations.

6 Glossary of terms Administration Charge A charge by the factor on each invoice for the provision of the service. Advance Billing An invoice raised in advance of the provision of the service to which it relates. Aged Debtors Ledger A listing of outstanding balances per customer and split by either the month in which the respective invoices where raised or the dates they become due. Agency Discounting Also referred to as disclosed invoice discounting. Where customers are aware of the factors involvement, but the company maintain the responsibility of managing their sales ledger. Approved Debtor / Balance A customer approved by the factor for the advance of the agreed prepayment. Asset Backed Lending Lending by an institution where specific security is provided i.e. invoice finance, asset finance (HP and leasing), stock finance. Opposed to lending under a blanket charge or debenture. Assignment The transfer of rights and benefit. Associated Company To a factor these include: parent companies, subsidiary companies, companies with common shareholders, companies with common directors, franchisees. Audit An audit of the company s systems and debtors will be completed by the factor (usually every three months), ensuring continuing satisfaction with their security position. May also be termed as survey, for example initial survey of systems and debt prior to the factor making a formal offer of facility. Availability The amount remaining available to draw from the invoice finance facility, considering advances may already have been made. BACS Payment Bank Automated Clearing System. A payment made or received through this system. Payments will generally take c.3 days to reach the recipient. Bad Debt An outstanding debt that will not be paid, most often given the cessation of the company invoiced. Ban on Assignment (BOA) A clause within a supplier s terms of trade that specifically bans the assignment of the benefits or proceeds of the sale or contract. Base Rate Base funding percentage above which an additional margin is added by the respective lender. All UK clearing banks currently operate with the same base rate determined by the Bank of England. CIS Certificate Contractors within the construction industry are required by the Inland Revenue to deduct tax when paying sub-contractors. Only if the subcontractor has the necessary CIS certification can the deduction be avoided. This is therefore of relevance to a factor, if invoices they have financed are liable to deduction by the customer (contractor). The factor s security being eroded. Very simply: * CIS 5 certificate permits gross payment by the customer * CIS 6 certificate permits payment gross to the company, but not to a third party, such as a factor. * CIS 4 requires deductions of tax to be made by the customer. If the nature of the company s business is subject to construction industry taxation then the particular certificate held will determine which factors are willing to be of assistance. Client A company making use of a factor s service. Collectability The ease of collecting in the full value of outstanding trade debts in the hypothetical situation that the company has ceased to trade. Affected by such issues as proof of delivery, disputes, contractual obligations etc. Concentration Used in reference to the spread of customers by balances outstanding. Some factors will apply a concentration limit, whereby should a single debtor exceed an agreed percentage of the total gross sales ledger at any one time then the amount above this limit would become unapproved. Confidential Factoring An alternative expression for confidential invoice discounting. Some factors are considering the provision of a true confidential factoring facility. That is, whereby the factor will complete the credit control responsibilities, albeit as if they were the company. Confidential Invoice Discounting An invoice finance facility where the factors involvement is not disclosed and therefore remains confidential from the company s customers. Also the credit management of the company remains its own responsibility. Consignment Stock Goods provided to a customer for which payment is required only once they have been sold on. Constructive Delivery Goods held for a customer that have already been invoiced but have not been delivered but stored on their behalf. Contra Account A customer that is also a supplier to the company. Contractual Sales Sales made within an over-riding supply agreement with the customer. Control Account Summary A monthly reconciliation of sales, credit note, receipts, adjustments completed by invoice discounting clients for the factor to check against their records. Correspondent Factor An overseas factor that is prepared to work with a UK factor to assist with the collection of export debts. The reverse can also be true, that is a UK factor being the correspondent factor. CPE - Credit Protection Element The proportion of the administration charge applied to cover the provision of bad debt protection. Current Account (Invoice Finance) An account maintained by the factor in the name of the client for the recording of all transactions between the factor and the client. Debenture A blanket charge over all business assets. Registered at Companies House. Debtor Credit Limit Individual customers may be given a credit limit by the factor above which balances will become unapproved. Dilution At any given time a debtor book against which the factor is advancing against will contain an element of debt that is likely to be subject to credit notes, discount rebate or adjustments. The factor will wish to establish this as part of agreeing the prepayment percentage advance against the debtor ledger. Directors Warranty Director s indemnity giving liability in the event of the company breaching specific clauses within the invoice finance agreement. These usually relate to the fraudulent notification of debt. Disclosed Invoice Discounting An invoice finance facility that is disclosed to the customers of the company by way of a note on the company s invoices. Unlike factoring the credit management remains the responsibility of the company. Discount Charge Interest charge. Discretionary Debtor Credit Limit A minimum credit limit applied to all customers irrespective any individual credit search information. Dispute A balance or invoice not accepted by the customer. Doubtful Debt A debt that has become doubtful that settlement will be made, given dispute or the viability of the customer. Drawdown A request to the factor to transfer available funds from the invoice finance account to the

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