What is Factoring?
Where did it come from? How was it developed?
It is said that they developed Factoring in the United States 100 years ago - or did they?
Others will tell you to look back in British history to the sixteenth century, when the new territories like the USA were being opened up and when most manufactured goods for those territories came from Europe. Owing to the slow communication and transport of these times, to sell in another territory it was a necessity to appoint an agent in the territory to find the customers, sell and deliver the goods for the principal and hold the principal's goods on consignment. These agents became known as mercantile agents and they also guaranteed payment to the principal. As the agents accumulated wealth they were able to pay the principal early, therefore they substituted themselves for the individual debtors, making themselves the principal, highly creditworthy, debtor. This gave birth to the modern Factor who purchases the debts from a principal, so the principal has only one highly creditworthy debtor.
But it is said by some historians the origins of factoring can be traced back to Babylonian times 5000 years ago. It is said to have been used in the Agricultural Industry of that period. A copy of a tablet showing the first "legible" written assignment of a debt dating back to the period 455 BC to 403 BC can be found in the University of Philadelphia, Pennsylvania, USA. If the early agricultural industrialists of Babylon 5000 years ago sustained their growth by the use of credit factoring, modern businesses should give very careful consideration to using such facilities today.
But we can say that modern Credit Factoring came to the United Kingdom from the United States in 1960 and by the early 1970's all the major clearing banks had either entered the market or purchased an existing factoring company. It has continued to develop over the years and has been increasingly used by small/medium size companies.
But what is meant by the term Factoring?
Perhaps this can be best described by defining what is a factor?
"A Factor is a "person" that purchases a debt that is owed to another and does so at a discount, in order to make a profit by collecting it." More usually today it is a company rather than an individual.
So factoring is the sale and purchase of debts.
Factoring is one method by which a business can increase its cashflow to fund expansion. Factoring is the only method of funding that reacts instantaneously to both increasing and decreasing sales alike.
What is offered in the marketplace in the UK today could be said to be more complicated than the simple statement of the sale and purchase of a debt at a discount. There are normally two charges levied by the Factor. These are given different names according to each factor.
The first is similar to a trade discount (known as Administration Charge, Service Charge or Commission). This is usually expressed as a percentage of the total debts offered for sale and is deducted from the sale price immediately. On occasion this is sometimes charged as a monthly flat fee, or a combination of the percentage and a flat fee.
The second discount is like a cash discount (known as Discounting or a Discount Charge). This is calculated on the amount of money prepaid to the seller before the factor receives payment from the ultimate debtor. The calculation of this discount is based on an interest formula and the cost is usually quoted as a rate over a bank base rate. The value of this charge can be controlled by the seller by controlling their cashflow requirements.
Some factors levy another charge, often known as a Refactoring Charge. This a charge based on debts that have not been paid by a set date. An example is any debt 90 days overdue or more that may have a supplementary charge levied on those debts each month; the charges range between 0.50% and 1.00%, until they are paid or repurchased at full face value by the seller.
As with any sale and purchase agreement, the seller warrants the quality of the debt - i.e. the debtor will pay the debt without query and on the due date.
But what are the services that factors offer?
These are often divided into two types of factoring:
1) Non-Recourse Includes protection against bad debts in case of the debtor's insolvency if the debt is within a limit set by the factor or the factor's insurer.
2) Recourse You repurchase the debt at full face value if the debtor becomes insolvent or a debt is not paid in an agreed period of time.
Within these types of factoring there are many variations of service offered and to ensure that you as a buyer are confused, different companies call the same service by different names. To help you through the maze I will divide the services down into their constituent parts and attempt to inform you of the options available.
* Some Factors send out debtor statements, others take over collections at 60 days
The above are some of the titles used by factors to describe their products. They are, also, sold under other names such as Bulk = Agency: Invoice Discounting = Confidential Factoring or Disclosed Invoice Discounting. Full Factoring incorporates Recourse Factoring & Maturity Factoring.
Each factor will package their service slightly differently. It is very difficult to make a direct comparison.
There are professional brokers to help you through the maze in an attempt to get you the right service for your company. There are a few, like myself, who have worked in the industry for many years and therefore have first hand experience of the industry.
© Copyright M E Gilbey May 2001
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