Advantage receivables

Before we look at the benefits of factoring and what it can do for your business, lets deal with what it isnt.

For too long there has been a degree of misunderstanding surrounding factoring, and its various guises. Many people, accountants included, still harbour negative attitudes towards factoring  a legacy from the 1980s when old-style factoring was struggling to get on its feet in New Zealand, and providers were far less selective in whom they engaged as clients. Consequently there were a number of associated business failures  but no doubt the writing had already been on the wall for these companies.

Fast forward to 2006 and the factoring sector is light years away from those early pioneering days. Today, talk of factoring being a last resort means of propping up a business is quickly dismissed by the service providers and the many companies that effectively capitalise on it.

Today, all kinds of businesses, from legal firms to building contractors, are using factoring short-term to free-up capital thats locked up in their debtor ledger  allowing them to re-invest that money into additional stock or plant, or indeed pay off their creditors. There are also businesses that utilise factoring to fund consistent growth long-term  and by long-term, were talking up to ten years and beyond.

Dave Cooper, Scottish Pacifics national manager, knows of one client that ten years ago offered large invoice discounts in an effort to generate sufficient cash to re-invest in stock. Factoring proved to be a far better solution, and helped drive the companys turnover from one million to five million in the first four years, and on up to $20 million today.

As the majority of business owners understandably seek opinion on accounting matters from their accounting professional, I thought it appropriate to speak to Tony Thomas, a regular contributor to NZBusiness and partner at Auckland accountancy firm Neesham Pike Thomas. He believes that factoring is generally gaining acceptance by his peers and sees it as a way to free-up cashflow and convert debtors (up to 60 days) back into real cash. Its about bringing cashflow forward.

Although there is a cost associated with factoring, Thomas believes its not as expensive as some people may think, and is particularly useful for start-up companies strapped for working capital. His advice to clients would be to consider factoring along with other forms of financing.

Also ask yourself are you using factoring for the right reasons? Will you use that cash within the business, such as more stock or to go into a positive expansion mode? And dont be afraid to ask for references from the factoring company youre talking with.


The options and benefits

Now lets examine the various forms of factoring, and the benefits they can deliver to businesses. Terry Haydon, director of Commercial Factors and Finance, splits factoring into the following groups:

Full service debt factoring. A company makes its total debtors ledger available to a third party which, usually on an ongoing basis, manages and administers those accounts. This could involve invoices totalling from $15K per month, well into six, even seven figures, depending on the factoring company. Debtors pay directly to the factoring company, so they are aware that a factoring company is involved.

Confidential factoring. A third party still manages and administers the invoicing as above, but the debtors see no indication that factoring is taking place. As in full service debt factoring, 80 to 90 percent of the invoiced amount is paid out immediately (potentially on the same day the invoice is raised) with the balance (minus interest and admin charges) paid when the invoice is paid.

Invoice discounting (not to be confused with discounting an invoice). A more corporate form of factoring which generally involves a company that has significant infrastructure and audit processes that allows assigning invoices in blocks. Often a bank is involved  funding advances against those particular invoices.

There is also one-off factoring and discounting of an invoice which can be arranged as and when necessary but, as with most short-term remedies, if used regularly is very expensive when compared to term factoring.

And if thats not enough options, Dave Cooper describes cooperation factoring  where the factoring company still sends out the statements and manages receipts, but the client is responsible for credit control.

Haydon explains factoring as a catalyst to speed up the business cycle.

The purpose is to free up money from an asset you own, but which is traditionally temporarily tied up. He says the cash should then be utilised to increase sales, negotiate discounts for bulk buys and prompt payment, reinvested back into the business or used to take care of obligatory payments such as GST.

In addition, unlike a fixed loan or bank advance, a factoring facility is open ended and increases in line with business levels  therefore meeting your increased cash requirements as your business grows.

Haydon says theres no need to continually apply for increased loan facilities as turnover goes up  it happens automatically. Forget about continually completing applications for increased lines of credit.

Other spin-off benefits of leaving the administration and management of your debtors ledger to a factoring specialist is better time utilisation; closer monitoring, which means less chance of overdue accounts getting out of hand; and ongoing control, thanks to online access to your debtors ledger anywhere and anytime.


And then theres debtor finance

Debtor finance is the term applied by the BNZ to its confidential invoice discounting (CID) programme, which involves the bank lending against the debtors (typically 30-day and up to 60-day debtors), and is a confidential arrangement between the bank and the borrower. According to Mike Skilling, general manager business banking, apart from the ability to generate immediate cash against a credit sale, in a sense turning a wholesaling operation into a retail cash generator, its greatest advantage is its confidentiality.

Skilling says the bank has seen a many times increase in clients, net revenue and funds out year on year since starting the service in 2002. And theres no sign of a slowdown.

CID lets a business concentrate on selling without the worry of funding the growing asset, he says. The security is the asset, rather than residential property. Too often SMEs rely solely on an external asset to support funding, but not so with debtor finance.

The BNZ can also offer evidence that debtor finance or CID can fuel business growth.

We have one client that has progressed from a $3 million turnover to $40 million, says Skilling.

As for implementing debt factoring, Skilling cautions businesses to research the options well. Pick a strongly backed provider as smaller ones may well have securitised their debt. Should they run into trouble a financier may even have to use your invoicing as security!

Make sure you understand your obligations under the arrangement says Skilling  above all, prepare well to grow your business.

And in case youre wondering why the BNZ has taken the initiative in this market segment, its largely due to the banks owners, the National Australia Bank, which has been highly active in the Australian factoring market (where debtor finance is accepted practice) for a number of years.

(In Australia and other countries, many factoring companies are, in fact, owned by the trading banks.)

Skilling says the majority of the banks clients dont stay forever in a CID relationship.

It could be six months or it could be two years  once their debt to equity ratio has improved or scale of turnover and profitability has increased significantly, or perhaps they take on a new equity funding partner  then they can look at other options.



Full service debt factoring, where a company effectively sells its invoices to a factoring company to accelerate cashflow, is becoming increasingly accepted in the business marketplace. Factoring is no reflection on either the company concerned or the debtor, explains Graeme Hill, general manager business development for S.H.Lock, another key player in the market.

He says when a factoring service is entered into, explanatory letters and phone calls inform all parties concerned. Once people understand how factoring works, he says theres never any issue.

Were simply acting as the collection arm of a company.

Hill says client companies are only too happy to hand over the hassle of managing the debtors ledger. And once a factoring partnership begins, service levels to customers actually rise.

We understand the importance of strong customer relationships, but with a third party involved pressure can be applied on slow payers without jeopardising those relationships, he says. Plus you no longer need to employ somebody simply to follow up bad debtors.

Hill says their aim is to enhance customer relationships, not change them, and certainly not to take over control of them. We know how and when to approach people, because we are very experienced.

Scottish Pacifics Cooper agrees that the customer relationship is of paramount importance  they maintain full transparency and dont mind being painted as the bad guy if their clients want to pass the buck a bit.

We would certainly never get heavy-handed without first seeking permission from the client.

Factoring is not for every company. For example its inappropriate for cash businesses on seven-day payments. Factoring doesnt suit retail businesses, or companies that want to get into large capital expenditure  such as buying major plant and equipment.

Its not recommended for businesses where contracts are involved, and clients invoiced for something that will be delivered in the future, says Cooper. The invoices have to be for goods or services that have already been supplied.

However, Graeme Hill says full service factoring covers a wide range of business circumstances. It is especially suited to companies experiencing a high level of growth, restructuring their business or those relatively new with a limited track record. He says S.H.Lock is a market leader when it comes to understanding clients businesses.

We have really invested in the technology and expertise to fully analyse any potential clients business model. Hill explains this includes looking at both historical and projected business performance and examining the key drivers in relation to these results. We look for ways to optimise our clients business opportunity and often full service factoring is an important part of the funding mix. 

The process of implementation of a full service factoring facility, outlined by Hill, is relatively easy and goes along the following lines:

Meet the potential client, obtain business details, financial accounts, etc and determine if factoring is appropriate. Provide intro pack  how the factoring process works, how it is implemented, and walk client through process.

Internally approve a funding offer for the client.

Submit letter of offer to the client, detailing terms and conditions of the factoring offer.

Drawdown the funds on receipt and verification of the clients debtors.

Hill says companies often start with full service factoring and with time migrate to invoice discounting or a normal working capital loan as they become more stable and established. S.H.Lock can offer a raft of funding services to clients depending on their current business requirements.

S.H.Lock offers working capital facilities and term loans, similar to traditional banking facilities but on more flexible arrangements, says Hill. He also says its possible to mix and match various funding options to suit particular situations.


Dont leave it too late

Dave Cooper knows many companies leave it too late to consider factoring. Dont look at it when a creditor suddenly doesnt pay on the 20th of the month  look at using it as a normal part of your borrowing portfolio, he says. He agrees that factoring gives a business a much better picture of its financial state, thanks to regular communication with the factoring company and close monitoring of sales and debtors.

Often the factoring company is the first to recognise that business is heading for trouble, says Cooper.

He says factoring offers many benefits, such as reducing stress on company administrators.

Lets face it, few companies are very good at credit control. They may be good at selling or inventing, but when it comes to collecting the dollars, they dont like doing it. Look upon us as your professional debt administrators  we can be as hard or soft on your customers as you want.

The cost of factoring will always be a potential stumbling block for many cautious business owners. Naturally there are set-up and legal fees involved, and generally ongoing fees will range from two to eight percent dependent on the factor period, number/size of invoices, number of active accounts, sales distribution network, the specific industry, financial structure of the company and its debtor payment history.

Certainly before proceeding, it would be wise to consider more than one factoring option, and examine the offerings of the key providers, to ensure that you are comparing apples with apples. There are important differentiators surrounding how, when, and if penalty charges are applied, and in regard to interest rates.

If youre concerned about the cost, perhaps you can take heart from a booklet put out by Commercial Factors and Finance which suggests that the real question is not what does factoring cost? but rather Can I convert the released cash from factoring and the time saved on debtor administration into profits greater than the cost of factoring?

If the answer is yes, perhaps it is time to investigate further.   NZB


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