544 Accounting: Business Reporting for Decision Making
Factoring or debtor/invoice/trade finance
Financial institutions have been inventive in finding ways to use the security of debtors to back business
loans. The variety includes:
- guarantee a general line of receivables or specific invoices
- factoring.
With guaranteeing a general or specific line of receivables, the borrower offers its debtors either in
total or in part as security for a loan. This method is simple and inexpensive to implement. However,
as the lender has no control over the quality of the debts, and there may be some potentially bad
debts included, normally the loan on a general line does not exceed a rate of 70–75 per cent of the
total invoices. With the guarantee of receivables, customers know nothing of the financial arrange-
ments that are being made, on the basis that they will pay their bills on time. The borrowing entity
collects its debts in the normal way and repays the financier according to the conditions underlying
each cash advance.
The second method of using accounts receivable as security is quite different. Factoring gives the
lender the right to collect the cash owing on invoices. Essentially, the factor discounts the invoices and
hands over the cash. It then collects the amounts owing by the borrowing entity’s customers. In some
cases, the factor buys the invoices outright, as well as the right to collect the funds owing. In other cases,
the factor gives a loan, collects the outstanding amounts, subtracts its fees and the loan amount, and then
returns the balance to the borrower. Factoring fees may be quite high. A fee of 5 per cent, for example,
when converted to a nominal annual basis, becomes 64 per cent if the 5 per cent was for the use of the
funds for 30 days.
Factoring has been growing strongly in the last 20 years or so, both in Australia and worldwide.
In 2005–06, the value of factoring was more than than $39 billion and in 2009 it was $61 billion. In
2012, the level of factoring totalled $63.3 billion. Factoring and discounting are normally highly suit-
able for entities that have rapid sales growth, that are unable to fund large orders or seasonal peaks,
and that regularly exceed their current overdraft limits and are fully borrowed against fixed assets.
Factoring and discounting are not suitable for entities with disproportionate levels of trade disputes,
or retailers with their myriad small sales. Reality check ‘Factoring Australia’ describes one important
task of this entity.
REALITY CHECKFactoring Australia
Factoring Australia is an Australian entity which provides advice on factoring, discounting and cash
management. One of their specialised tasks is to come up with a factoring or discount strategy to suit
each client’s needs. To do this they conduct a thorough profile of each client’s financial circumstances
and then provide the information to different factoring entities that would be an appropriate match to
the client. The factoring entity will then make a quote for the services that they are going to perform for
the entity. The factoring entity will then carry out an audit of the entity’s books and records and will then
make a formal offer to the entity and make the cash payment to the entity as soon as all information has
been verified and the appropriate legal documents have been drawn up. Throughout this entire process
Factoring Australia acts as the broker.
Source: Factoring Australia website, http://www.factoringaustralia.com.au.Inventory loans or floor-plan finance
The final asset able to be used to secure short-term finance is inventory. The quality of inventory as a
security depends on its nature. Essentially, quality, age, perishability and marketability all impact on the
usefulness of inventory as security for a loan. Think of some examples where you would not like to lend
funds with that sort of inventory as the security.