Chapter 7 Trade financing techniques
The factoring process
The factoring process is as follows.
The company raises an invoice.
The invoice is sent to the customer, with
instructions to pay funds to the factor, and
is copied to the factor.
The factor approves the invoice and pays
the agreed proportion to the company.
The factor collects payment from the
customer. This may include action to
chase payment.
Once payment is received, the factor
will pay the balance between the funds
advanced and the payment, less any fees
and late payment charges that apply.
On some occasions the factor will be unable
to collect the payment from a customer. What
happens next is determined by whether the
factoring agreement gives the factor recourse
or not.
Recourse factoring.
Where recourse factoring has been
agreed, the factor is able to claim any
unpaid debts from the company. The
factor will also levy interest charges
and the usual fee. Interest charges will
be set at a pre-agreed margin over the
relevant local base rate. Fees are usually
a function of the company’s turnover
(anything from under 1% of turnover to
over 3%) and perhaps the number of
customers or invoice cycles per year,
which may be stepped to adjust for a
company’s growth. The company has the
right to chase payment from its creditors.
Non-recourse factoring.
With non-recourse factoring the factor will
not be able to reclaim any unpaid debts
from the company, although the company
may have to pay interest on unpaid
items for the period determined in the
agreement. The factor will have the right
to seek payment from the creditors.
Recourse also has accounting implications
for the company. If the factor does not have
recourse to the company, the risks and
rewards associated with the factored invoices
are usually transferred to the factor. If so,
the transaction can usually be accounted for
in the same way as a sale of receivables.However, if the factor does have recourse
to the company, the risks and rewards are
not usually transferred to the factor, so
the transaction may be accounted for as a
loan. Because of the potential complexity of
individual transactions, specialist accounting
advice should always be sought.Export factoring
The same factoring technique can be used to
raise finance from international transactions,
although it will depend on the international
capabilities of the factor. In effect, for export
factoring to be available from a factor, that
factor needs to be able to collect payment
from the importer. This may require the
factor having a presence in that country
responsible for collection of payment. This
may be through one of its own subsidiaries or
branches, or via a correspondent partner in
that country.
When arranging an export factoring
transaction, the company will need to
consider carefully whether the cost of
factoring represents the best method of
financing. In particular, because factoring
involves the outsourcing of accounts
receivable, the company will want to ensure
the factor has sufficient economies of scale
to be able to provide that service more
efficiently than the company itself could.
From the factor’s perspective, the cost
charged could vary significantly with the
volume of sales for the same reason. Much
will depend on the location of the exporter
and the markets into which the exporter is
selling. For example, the costs to the factor
will tend to be lower for a UK company
exporting to other European countries than
when exporting to Latin America or Asia.
If the company is considering export
factoring it is important to try to identify the
best possible transaction. For example,
export factoring may offer the company the
opportunity to manage foreign exchange
risk, by agreeing a contract with the importer
in the importer’s local currency (for ease
of sales) but accepting financing in either
the company’s operating currency or in the
currency in which the company has to pay
for raw materials. It is important that the
opportunity cost of this foreign exchange risk