Lifelines of credit

As a cashflow management tool, debt factoring is finding increasing favour amongst Kiwi businesses desperate to fuel growth in a sluggish economy. Glenn Baker investigates the variety of factoring products and how they work.
According to the e-font of all knowledge, Wikipedia, factoring’s origins lie in the financing of trade and was underway in England as early as the 14th century. Originally the factor company had physical possession of the goods, provided cash advances to the producer, financed the credit extended to the buyer and insured the credit strength of the buyer.
Like all financial instruments, factoring has evolved over the centuries, and today, says Wikipedia, is “well suited to the demands of innovative rapidly growing firms critical to economic growth”.
Put in more simple terms, factoring is a line of credit to secure cashflow. It has long been a mainstream financial tool in Europe and the US, is regularly offered in Australia, and its popularity has been steadily increasing on this side of the Tasman in recent times too.
Kiwi business owners experiencing tough trading conditions are turning to a number of credit options to maintain headway. Worryingly, many have been resorting to personal credit cards to finance cashflow and meet working capital needs. Massey University’s Centre for SME Research discovered back in May that personal credit cards are now the most widely used form of business finance alongside trade credits. If that doesn’t highlight the fragile nature of the economic recovery, I don’t know what does!
Debt factoring, also known as ‘receivables finance’ in Australia, may appear complicated to business owners, or perhaps a ‘last resort’ option. Nothing could be further from the truth. It’s simply a line of credit linked to and secured by what you are owed. 
Scottish Pacific Business Finance (Scotpac) uses the example of a furniture importer, wholesaling to other businesses, to explain the concept. He buys 100 chairs for $2500 and sells them for $5000. But rather than wait 55 days for the cash to come in, the factor pays $4000 against the $5000 invoice within 24 hours, and the balance, less fees, on full payment by the debtor. The importer can immediately buy 160 more chairs to sell for $8000 – to which the factor can advance $6400 – and so the cycle repeats as long as necessary.
Ah, ‘but those fees; isn’t factoring expensive?’ I hear you ask.
To use a Scotpac example again: monthly invoices of $100K will cost you $2800 in admin and interest over say 60 days. But compare that to the cost of a five percent discount for prompt payment – $5000 (which you still have to wait until the 20th of the following month for).
You get the cash within 24 hours of raising the invoice – plus receipting and collections attended to, and credit advice on your larger customers.
WHK business advisory principal Catriona Knapp agrees that a clear benefit of a debt factoring arrangement is the utilisation of the factoring company’s excellent debt collection skills – skills which many business owners will admit they’re short on.
“Business owners and managers are very busy – and for many, debt collection is not a strong point. The fee they pay to the factoring company to manage those debtors, they would normally have to pay to someone to manage them anyway,” says Knapp. “And factoring companies are very skilled at following up payments.
“It’s especially useful for businesses that produce a high volume of invoices – for business owners who’re practically minded, and not necessarily as administratively focused as they should be.”
Knapp also sees factoring as a real cashflow opportunity for businesses that are perhaps seen as too risky by the traditional lending institutions.
“Even if you may not want to utilise the service for your local customers, if you have customers in Australia, the use of debtor finance from say Scotpac, which also operates across the Tasman, to secure invoice payment over there, could be a worthwhile advantage.”

Factoring times

The challenging cashflow environment continues to positively impact the factoring market. Figures just released by The Institute for Factors and Discounters (IFD) in Australia show receivables finance to businesses there grew in the three months to March to $14.3 billion, up 6.6 percent on the March 2010 quarter. The total for the year to March 2011 was $59.5 billion.
IFD chairman Tony Della Maddalena believes the industry will continue to grow as the economy recovers, and there’s a rise in sales and corresponding debtor levels. Now is the time for businesses to ensure they have sound credit lines in place, he says.
Meanwhile in New Zealand, more players are entering the market. Comparing the market today with that of five years ago, Scotpac’s national manager-New Zealand, Dave Cooper, says there are now a number of providers who will factor individual or one off invoices and, although very expensive, they play their part in a short-term funding solution.
“There is also a tendency to sell ‘undisclosed’ facilities to clients, more from the fact that the providers cannot provide good levels of service to assist in collecting the money from the client’s customers, whilst still charging a premium for the undisclosed facility,” he says.
“Unfortunately there is still a lot of misunderstanding surrounding debtor finance facilities and a lot of companies looking into it probably a little late.”
Cooper, too, thinks debt factoring will grow on the coat-tails of the economic recovery and reminds us that the finance facility is tagged to the size of the debtors ledger. “So if the debtors ledger is $1m and the funding rate is 80 percent, then the client can have $800,000. If the ledger grows to $1.5m, then the client can have $1.2m.
“Scotpac will definitely be around to support these growing businesses.”
Another finance company that’s looking forward to growth in the market is Lock Finance. CEO Simon Thompson believes that noise from the more recently arrived players such as Marac is helping debtor finance and factoring become accepted mainstream products.
“We’re also seeing a move towards ‘supply chain finance’ where we finance inventory much earlier in the supply chain process,” he says. “We can load against purchase orders in order to assist payment for goods before they’re invoiced out.”
Thompson says the arrangement works especially well for seasonal fluctuations. “A typical scenario is an importer supplying seasonal goods for The Warehouse or Briscoes. They have a confirmed order and have to stump up with say $500k. We can fund $300k upfront so they can bring in the goods and invoice the customer, and let us factor the rest.”
Thompson has seen a resurgence in interest in factoring in recent times, fuelled by the extension of debtor days, cashflow restraints, and the impact of the Canterbury quakes. He’s predicting greater focus on supply chain finance in the months ahead – not just invoice finance – and wouldn’t be surprised if more banks leap into New Zealand’s factoring space in the not-too-distant future.
There is often a pattern with the take-up of factoring products too, he says. Startup businesses especially may start with traditional item-by-item, debtor-by-debtor products, and then mature into more commercial debtor finance products which lend against the whole ledger, are easier to manage and less obtrusive. “But for smaller businesses with not much trading history, and therefore a higher risk factor, more traditional debtor by debtor factoring may work better.”

Quick results

Applied correctly, factoring can have an almost immediate affect on a company’s cashflow. Some companies are reluctant to put their hand up, preferring to keep their financial management to themselves. However, Lock Finance’s Simon Thompson knows of one South Island client experiencing tight cashflow and utilising both debtor and inventory finance, who moved to the full factoring service and in three to four months improved the current debtors collection rate from 50 percent to 75 percent. Which meant a lot more cash was available.
“By keeping the client’s ledger more current we were able to provide the cash quicker and allow it to better fund business growth,” he says.

Another satisfied believer in debt factoring is Rachel Goninon, director of corporate apparel importer Texet Ltd.
A recent new client of Scotpac, Goninon chose debt factoring over taking out a loan, after the subject kept popping up in conversations, and she learnt that some of her bigger competitors had been utilising the service for some time.
She opted for the whole-of-ledger, full disclosure service, after first checking with a couple of top customers to see how they felt about being serviced by a third party. Turns out they were also debt factoring converts and the feedback was all positive.
Goninon likes the factoring concept because it’s “funding business through your business”, and the fees weren’t ‘astronomical’ as she’d been led to believe.
“Suppliers are often the last to get paid, up to 90 days out, so it’s nice to now get the cash up front.
“Also, I run the business myself, I don’t want to employ someone just to manage the business’s credit control. So it’s great to be able to hand that responsibility over to Scotpac.”
A client of Commercial Factors & Finance, a company that provides cashflow, working capital and debtor admin solutions, is also enthusiastic about how factoring eases the worry of seasonal cashflow difficulties. “I love the ability to present a single invoice for factoring on a casual basis, knowing the service is prompt, reliable and cost effective. It takes the worry away when managing cashflow at certain times of the year.”

About those misconceptions

No article on debt factoring would be complete without addressing the many myths and misconceptions that still exist out there.
For a start, many people may think their business automatically qualifies for a factoring product. Not true. Factoring companies are lending institutions and, as such, new business must meet certain criteria to minimise risk.
Lock Finance’s Simon Thompson says they examine the moveable assets: debtors, accounts receivable, inventory, etc – and satisfy themselves that the business’s commercial processes are sound – such as back office systems and buyer terms of trade.
Scotpac’s Dave Cooper says they look for the following in a potential client:
• A good product or service.
• A desire to use the funding made available to maintain or grow the business.
• A reasonable plan to ensure that the business has a future.
• A spread of customers.
• The funding provided will make a positive difference.
Then there is the chestnut that factoring is a last resort. Cooper responds by saying they have clients for an average of four years, but some are still with them after 15 years, and are very successful. “Those who treat it as lender of last resort will not get a facility from any reputable factor.”
Is factoring expensive? Not when compared to a bank overdraft say the experts or, as explained earlier, a five percent prompt payment discount.
“There are two charges,” explains Cooper. “An admin fee for work done on the ledger and an interest charge calculated on the money you’ve borrowed. If you borrow nothing you pay no interest. If you borrow $100k today you will pay interest on $100k today. If your debtors pay us back $75k tomorrow, you will pay interest on the remaining $25k.”
Will your debtors want to deal with a factoring company? Some business owners mistakenly think no. Cooper’s response is that they have small, medium and large companies paying them directly, and they’re all treated in a professional manner.
“We are not bad-debt collectors. That is not our game. We don’t threaten them either because they are the number one asset of our client. We want our clients to grow and refer business to us, so we are not about to start losing our clients’ customers,” he says. “Generally we find that if we are doing the administration the customer doesn’t care who he pays, so long as he is getting a good product or service.
“Of course, for undisclosed facilities this is not an issue.”
There’s also a myth that factoring is easy to get into but hard to get out of.
“Like all loans, the way you get out is to pay off the loan,” says Cooper. “If you pay off the loan you get out of the facility, same as if you want to get rid of your mortgage.”
And, rather than suppliers or customers being turned off by the fact that you’re factoring, the reality is they should actually have more confidence in you because factoring companies won’t take on bad businesses. “Our involvement will normally mean that your suppliers get paid quicker, because you are turning your business into a cash business,” says Cooper. “Your customers should be happier because you will generally get better deals from your suppliers. “The fact is, almost every business borrows money; from the bank, from shareholders, friends, investors, suppliers, even the IRD by delaying payment to them. Borrowing from a factor is no different. If you can turn the funding into a profit-making opportunity, then surely it is a sensible option.”