# ECONOMIC FACTORING ROLE AND ITS ADVANTAGES COMPARED WITH DEBT COLLECTORS AND BANK CREDIT TO SMEs IN ALBANIA

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4 Volume 4 Number 4 June 2015 costs for this process goes to suppliers, and also defines an extra cost for accounts that qualifies as unsafe. Both these types of costs classified as additional cost in credit financing option. The collection period is 30 day The company takes maximum loan for a month, must choose factoring company or "BKT" bank? Let's calculate the costs when the supplier chooses to finance with factoring: The cost of processing receivables ( ,000 ) = 4,000 Borrowing cost (0.03 \$300,000) = 9,000 The total cost of financing with factoring= 13,000 Let's calculate the costs when the supplier chooses to finance with credit: Interest costs ( ,000) = 6,000 Accounts committee procedures ( ,000) = 6,000 Additional costs that are not applied by factoring companies: Costs analysis of suppliers situation = 2,500 Bad debts cost (0.02 \$400,000) = 8,000 Total additional costs = 10,500 The total cost of bank credit financing = \$22,500 Conclusion: The Company must seek financing through factoring. So, as seen from the example in relative terms, the bank offers more favourable conditions than factoring company, but the bank has a lot of additional costs that make the bank loans more costly. Moreover in the above analysis, the collection period of accounts receivable is too small so to pronounce even more as favourable option the factoring financing Analysis 2 The manufacturing company "RA METAL" needs 250,000 euros and is considering alternatives to a bank loan from the, "BKT" bank and a factoring financing by "IFIS" factoring. Analysis of credit financing: The terms of the bank loan include interest discounted 18% to 20% of a offset balance. The Bank also calculates costs on accounts that qualify as a bad debt. Uncollectible accounts are estimated to be 3% of receivables financed by the bank. Analysis of financing with factoring: Factoring Company "IFIS" will load with 4% commission for bills purchased per month and interest rates for bills purchased is 12%, discounted in advance. Which option is better? Page 43

5 Volume 4 Number 4 June 2015 Bank loan that is provided to suppliers will be calculated as follows, according to the terms of the above mentioned: = The net value of the loan /(100% - Discounted derived value) 7 = 250,000/[100% - (8% + 20%)] = 250,000/( ) = 250,000/0.72 = 347,222 Let's calculate the effective interest rate bank loan which is: The effective interest rate = Interest /Derived value (%) = 0.08/0.62 = 11.11% Based on calculations, the total cost of bank loan is: Interests (250, ) = 27,777 Additional costs that are not used by the factoring company Uncollectible accounts (347, ) = 10,416 Total cost = 38,193 The amount of receivables that will be financed by the factoring company is: = Accounts receivable / ( 1- [purchase bills interest + service commission]) = 250,000/( ) = 250,000/0.84 = 297, 619 The effective interest rate for accounts receivable, financed by factoring is : The effective interest rate = Interest rate /derived value (%) = 12%/[(100% - (12% + 4%)] = 0.12/0.84 = 14.3% Which it indicates that the total cost of factoring alternative is: Interests (250, ) = 35,750 7 Reviewed by source: Page 44

6 Factoring Commission (297, ) = 11,905 The total cost of factoring option = 47,655 Conclusion: In this case, the factoring agreement provides higher costs than the bank's option, making it more difficult to determine which option is best. While banking costs are lower, the supplier will normally choose the loan financing but only if the timing allows to perform all banking procedures for obtaining credit. Considering the above analysis, we conclude that to determine whether or not factoring is a good option for financing depends on many factors, which are described clearly in factoring agreements and also in the terms and costs involving the bank for the loan approval. 3. The difference between factoring and debt collectors 3.1 Debt collectors: Volume 4 Number 4 June 2015 Debt collectors specialize in taking debt out of the hands of companies that have allowed customers to buy on credit. They often take over the full debt by buying it out of business for a fee and then try to collect it themselves. Other debt collectors help businesses with outsourcing, by allowing them to pass on all receivables and by believing in the methods of debt collection agency. Then the agency will pass back the payments to business, by reducing their fees for service basis. 3.2 Factoring companies: As debt collection agencies, factoring companies work to care for the debts on behalf of businesses. Factoring companies for the majority of businesses compile tight budgets from period to period and collect debts in as much reliable way as possible Factoring company takes over debt collection, but differently from debt collectors, they allow businesses to borrow, based on their debt, by withdrawing money from the money of the factoring company, but for this retreat, businesses pay the factoring company for collecting debts as well as for using their money. 4. Empirical assessment made on the Albanian market which SMEs are most likely to use factoring. One of the objectives of our paper, as we have noted above, has been the highlighting and proving that factoring is a very good option for financing the firms, which are in their beginning with insufficient collateral to take loans from banks, but have a positive result, in the statement of income and expenses. So are firms that Page 45

7 result with profit but are in financial difficulties because they lack liquidity. Relying on empirical studies 8 that they are made in different time periods in the UK, United States and Italy, countries which is achieved the greatest volume of factoring industry on a global scale, have defined that the development index is one of the important factors that affect the the use of factoring. Development Index Sales t Sales t 1 Company growth: ( ) Sales Volume 4 Number 4 June 2015 t 1 This indicator is calculated by taking the data from the statement of income and expenditure of firms, by dividing the difference between the current year's sales with sales of an earlier period with sales of an earlier period. This theory has been studied by many researchers in the economic field as Noly in 1969, Beecham in 1988, Palframan in 1989, Hawkins in 1993, Smith and Bickers Schnucker in 1994 and in For this reason, we take on the study of 110 small and medium enterprises, which operate in different sectors of the industry and have special features between them. After defined dependent variable (Factoring) 9 and independent variables (growth of companies), we have selected the statistical method of simple regression, to test the firms included in the study, the impact of this variable in using the factoring as a source of short-term financing for SMEs in Albania. We will empirically confirm the link between dependent variables and independent variables by using regression analysis method, by confirming the following hypothesis: Hypothesis: Are SMEs, with an "aggressive" growing, more focused in using financial factoring as short term funding source? 8 Mian and Smith (1992) Accounts Receivable Management Policy: Theory and Evidence, The Journal of Finance (47): Smith and Schnucker (1994) An empirical examination of organizational structure: The Economics of the Factoring Decision, Journal of Corporate Finance (1), Pg Soufani (1999) The Role of Factoring in the Financing of Small Firms in the UK, Ph. D. Thesis, Nottingham University, Sh. Çela Factoring, short term funding source for SMEs in Albania "Paper Ph.D. FEUT.2014 Page 46

8 Table 4.1. Net sales for firms in the study.. Net sales growth % Number of firms in the study Number of firms use factoring % of firms that use factoring 1-5 % % 6-10% % 11-20% % 21-50% % % % Over100% % Total % Source: Empirical Study of the author Volume 4 Number 4 June 2015 To prove this hypothesis, we used financial statements for a period of 4 years of SMEs considered in the study. As we stated above, they are 110 out of which only 26 use factoring as a funding source. We have cut from the financial statements, the statement of income and expenses (income statement) and have calculated the net sales growth. As seen from Table 4.1, from the calculated reports, we have easily noted that firms that are using financial factoring have a increased percentage, of net sales. They belong to increased intervals, the majority by %, which really is considered a very high growth rates. This result, by our point of view, comes from two reasons, the first one comes from the production units growth, or of the sales volume, and the second by the increase of price per unit. But as we found out that these firms are relatively new in age, then it makes us to reinforce our opinion that this increase in sales is more due to the increased volume of sales than the increase price per unit. That's how we have proved the hypothesis above. Picture 4.1. The link between increases in sales and the use of factoring. Page 47

9 So as seen from the equation of the graph, there is a positive correlation between the increase of sales and the level of use of factoring. This clearly expresses positive signs beside X. R also presented positive value but less than 0.5, it for the only reason in our opinion, because the use of financial factoring in Albania is in its infancy as an industry and it clearly expressed by our empirical study. That's how we have proved the hypothesis above. 5. Conclusions Volume 4 Number 4 June 2015 In conclusion we can say that it's easier for business, to provide immediate liquidity through factoring financing than through bank loans. Most factoring companies will adopt a factoring contract on the basis of a positive position of the company that is seeking a sale of accounts receivable and there will be no need for financial statements or payment of any guarantee Another very important point of factoring is that factoring contract, signed between the supplier and the factor, estimates more accounts receivable risk than the risk of the supplier itself. e.g. factoring can be better used to finance receivables of a major client or foreign, who has the confidence rate higher than the supplier itself. In this case they make the evalution of the reliability of the accounts receivable and non-reliability of the supplier 10. Factoring is a predominantly form of financial instruments and an important source of external funding for small and medium enterprises (SME's). Factoring is not a traditional investment, but an industry where can act people who want to make a fortune, taking into account the risk and quality of factoring service. There are at least two differences between factoring and bank loans, which are in favor of factoring as a better financial alternative for small and new firms : First, these two alternative means of financing, change according to the type of collateral. In the case of factoring, accounts receivable which are yet unrealized assets used as collateral, while in the case of bank loans are stable assets that are used as collateral. This difference is very important because, as noted, small and medium companies generally do not have sufficient assets to secure the loan. Secondly, the difference between factoring and bank credit, is in the credit risk assessment process. While banks are interested in credit analysis of the firm which is seeking credit, factoring companies investigate qualitative and quantitative characteristics of its supplier and its customers 10 Factoring & Forfaiting, A business and regulatory prespective, Ernest & Young, Qershor Page 48

10 Volume 4 Number 4 June 2015 Factoring reduces overall costs in cases where can apply for commercial loans and has short application time, as credit analysis is not over in time and also takes specific prepayments. Firms that have a positive result in the income statement and are characterized by a very rapid growth, which could be considered a "aggressive" growing, are more focused on the use of factoring as a source of short term financing. 6. Reference Nash, Carson, Management-Accounting, Factoring - Financing for Companies Seeking Fast Cash, Creative business planning Incorporated. Management-Accounting, Carson Nash The Edwards Research Group, The Basics of Accounts Receivable Factoring. Reviewed by source: Mian and Smith (1992) Accounts Receivable Management Policy: Theory and Evidence, The Journal of Finance (47): Smith and Schnucker (1994) An empirical examination of organizational structure: The Economics of the Factoring Decision, Journal of Corporate Finance (1), Pg Soufani (1999) The Role of Factoring in the Financing of Small Firms in the UK, Ph. D. Thesis, Nottingham University, Sh. Çela Factoring, short term funding source for SMEs in Albania "Paper Ph.D. FEUT.2014 Page 49

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