The Treasurer’s Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

management is considered when evaluating
the cost of export factoring.
In terms of the overall conditions,
export factoring works in the same way
as domestic factoring. The factor may
advance a lower proportion of the finance
because of the associated risk. Again, this
opportunity cost needs to be evaluated by the
company before agreeing the relationship.
The company may be required to arrange
additional credit risk insurance as further
protection for both parties. This also needs to
be incorporated into the evaluation, bearing
in mind that the company may arrange credit
risk insurance anyway.

Advantages of factoring

There are a number of advantages from
factoring.
ƒ Factoring provides clear working
capital finance at the time it is needed,
not according to the terms of a loan
agreement or overdraft.
ƒ Finance is provided against invoices so,
subject to any credit limit being imposed,
finance can be available as a company
grows.
ƒ Invoices are reserved for short-term
working capital financing, meaning other
assets such as property are available
to secure other, perhaps longer-term,
financing.
ƒ The company has access to cash once an
invoice has been raised, allowing it to be
invested back into the business. There is
no requirement to use overdrafts or other
unsecured funding to bridge a delay in
payment terms.
ƒ Factors employ specialist accounts
receivable teams, effectively outsourcing
this activity. This reduces operational
costs within the borrowing company. At the
same time, the factor’s expertise will help
to identify worsening credit risks amongst
the company’s customer base, reducing
the risk of potential future loss.

Disadvantages

As with any other form of financing, there are
disadvantages to the use of factoring.
ƒ Invoices are among the most attractive
formal or informal sources of security for

lenders. It may be difficult to raise other,

especially short-term, finance if invoices

are already committed to a factor.

ƒ Factoring can be relatively expensive,

although the service does effectively

include a debt collection/accounts

receivable team.

ƒ Factoring is disclosed to the company’s

customers, which can weaken the trading

relationship between the parties. There

is also a reputation risk: for example, if

the factor is particularly aggressive in its

dealings with the company’s customers,

the company could lose sales to a rival

supplier.

ƒ By analysing customers’ payment

practices, the factor could put pressure

on the company to reduce sales to certain

of them.

ƒ In a weak trading environment, increasing

proportions of the company’s cash will be

spent on interest payments to the factor.

ƒ If the factor fails, this could cause serious

problems for the company.

ƒ It can be difficult to end a factoring

relationship, as the company will rely on

the cash from the factor to fund working

capital. Even finding the resources

for gradual replacement of a factoring

arrangement can be difficult.

Evaluation

Factoring certainly provides some companies

with the ideal way of funding working capital.

It works best for small and medium-sized

companies where the company has a

relatively large number of customers, all

trading on the same terms.

It is less effective where the company

is reliant on a small number of customers

(or one major customer), or where each

customer has negotiated its own terms.

Although large numbers of standard invoices

are appropriate as a basis for factoring, the

relationship is less likely to work if the invoice

values are too small.

Finally, a factoring relationship works best

and is most effective when the factor has to

do little work to collect payment. The more

effort taken by the factor to collect payment,

the higher the interest charges and fees the

factor will apply.