BOOKKEEPING SYSTEMS INTRODUCTION TO FACTORING CONTENTS Page 1. What Is Factoring?... 2 2. Factoring Overview... 2 3. How Does Factoring Work?... 2 4. Alternative Method Of Factoring... 3 5. Benefits Of Factoring... 3 6. What Do You Do With The Money?... 3 7. Using A Key Asset On The Balance Sheet/Sundry Debtors... 4 8. Acceptance Of Factoring... 4 9. Factoring Is A Large Business... 4 10. Information Required By Factorer... 4 Page 1
BOOKKEEPING SYSTEMS INTRODUCTION TO FACTORING 1. What Is Factoring? Factoring is not new. It originated in England in the 1300 s. Today it is a common method of financing business transactions. The factoring company purchases a business debtors invoices for a fee. The benefit to the business is that it receives cash for a high percentage of its debtors invoices, virtually simultaneously with the sale. For further information, refer to Paper 005-005 - Sundry Debtors 2. Factoring Overview There are a range of finance options available to small businesses that can provide an immediate boost to cashflow. Debtor factoring, which is sometimes called invoice-discounting or debtor finance, effectively allows a business to borrow against the value of their debtor book. Businesses in sectors with very long payments terms, such as manufacturing, clothing, wholesale, mining, professional services and printing are suitable businesses for debtor financing. Businesses that are offering credit terms and then operating large debtors accounts could consider freeing up a significant amount of their investment in debtors by entering into an arrangement with a bank or specialist debtor financing company for receipt of cash advances against the business debtors ledger. This sort of financing doesn't normally require the business to mortgage personal assets as the financing is all reliant on the level of debtors owing to your business. 3. How Does Factoring Work? There are a number of well-established companies which offer factoring. The business operator negotiates with the factorer, who agrees to make factoring facilities available for a set fee, and to make a set percentage cash advance to the business operator. Page 2
The deal normally involves the factoring company agreeing to pay for a high percentage of a small business approved invoices within 48 hours of the invoices being presented to the factoring company. The following example will highlight how factoring works: ABC Company agrees to sell to XYZ and the sale price is $10,000. ABC Company forwards the original copy of the invoice to XYZ (the customer) and presents a copy of the invoice to the factoring company. (So long as the purchaser (XYZ) has been approved by the factorer). The factoring company will deduct the value of its factoring fee, say around 2% or 3% above the bank bill rate from the invoices presented to it. (say $200). The factoring company calculates the advance percentage that has been agreed upon for that particular customer, say 80%. ABC would receive $7,840 as an advance against the invoices made out to XYZ. ($10,000 - $200 = $9,800 x 80% = $7,840). When XYZ subsequently pays in 70 days time, $10,000 would be received. Of this, the factoring company would retain its original fee of $200 and the advance of $7,840, a total of 8,040, and would remit the balance still owing to ABC of $1,960. The business ultimately has received $9,800 - and had the use of $7,840 for the 70 days that it took XYZ to pay. This procedure would be undertaken with the statements having been forwarded in the name of the factoring company. 4. Alternative Method Of Factoring There is an alternative method of factoring, which is a confidential factoring, in that the business customers are not aware that the debtors have been factored. This means that invoices, statements etc. do not mention in any way the name of the factoring company. This can mean that a higher fee is paid, but it is perceived that the client benefits in that it is not known that debtors are being factored. 5. Benefits Of Factoring Factoring can have tremendous cash flow benefits for small business operators. In the example given the customer, XYZ, would normally have taken until 70 days after the invoice is raised, to pay for the goods. If ABC was factoring its debts then the company would receive the use of $7,840 within about 48 hours of the invoice being written. This means that the bulk of the amounts owing would be in the possession of the small business for approximately 68 days prior to the normal payment date. 6. What Do You Do With The Money? It is anticipated that if you are using factoring you will be able to use the cash generated to reduce other borrowings, buy product at favourable purchase prices, pay Goods and Services Tax or pay PAYG taxation payments. Page 3
7. Using A Key Asset On The Balance Sheet/Sundry Debtors The problem that many small businesses are facing is that in difficult trading conditions, banks are reluctant to lend money by way of bank overdraft or increased mortgage loans, but for many small businesses, there is a key asset on their balance sheet - "Sundry Debtors". There are specialist debtor finance/factoring companies, as well as banks who, subject to minimum turnover levels and the quality of the business' customers, are prepared to advance funds against an invoice. Once established, the factoring transaction can be concluded within 24 hours of an invoice being raised. This allows the business to have the use of cash a lot quicker than what it would probably have had, given that the Dunn & Bradstreet Report on debtors' balances for the September 2011 quarter indicated that it is now taking, on average, 53 days for bills to be settled with businesses. This is 3.3 weeks beyond the normal trading terms specified by most businesses. 8. Acceptance Of Factoring Factoring is becoming more popular in Australian business and it is one financing opportunity that small business operators should be considering if they have to trade with customers on a credit basis. However, many of the factoring companies have restrictions on the size of the business that they are prepared to deal with and most demand annual credit sales of at least $500,000 before they will consider making factoring available. However check out in the market place as to the type of deals that can be negotiated. 9. Factoring Is A Large Business Factoring and discounting is a large business. The Institute of Factors & Discounters has indicated that factoring and discounting turnover in Australia for the 12 months up to 31 st March 2011 was $59.5B. If your business is offering credit to customers, and therefore you have an amount owing to you in sundry debtors, entering into a factoring/debtor financing arrangement will probably enable you to access a significant amount of cash without having to offer security over real estate. 10. Information Required By Factorer The factoring company will also require to sight annual financial accounts together with periodic financial accounts and business plan. They will require permission to conduct an audit on your debtors affairs. Many small businesses have found that the inconvenience of the controls that the factoring company insists on and the fees, are acceptable by allowing them the benefits of having substantially improved cash flow from their credit sales. For further information, refer to: Paper 001-050 - Sources Of Finance Paper 005-050 - Management Departmentalised Accounts Paper 009-008 - Business Plans - Key Points To Be Included Page 4
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