FAQ – IFD
Q. What is factoring and discounting?
A. Factoring and discounting involve the assignment of
debts by a business (the assignor of the debts, usually
referred to as the client) for consideration, generally
on a continuing basis.
There are various ways the purchase transactions are
structured. For example, the debt can be sold to the
factor/discounter for a price that is less than the face
value of the debt. In this case the factor/discounter
pays the business up to 90% of the invoice value in cash
and the balance, less fees, is paid to the business after
a set period, or after the debt has been collected. Sometimes
the debt is purchased for its full face value and then
a prepayment of the amount owed is made based upon an
agreed prepayment rate.
Q. What is the difference between factoring and discounting?
A. Under both facilities the client sells the unpaid invoices
for immediate access to cash, but under the factoring
arrangement the factor additionally manages the client's
sales ledger and collection of accounts. Therefore, under
a factoring arrangement the debtor makes payments to
the factor. Under discounting, the debtor nominally makes
payments to the supplier; but as the debt is owned by
the discounter, the supplier is collecting these debts
on behalf of the discounter.
An example:
- The client has a $110 debt;
- The client sells the debt
to a factor/discounter;
- The factor/discounter makes a
$90 upfront payment to the client;
- The factor/discounter
earns a $1 administration fee;
- The factor/discounter also
earns a discount fee (usually a daily charge based
on usage, similar to interest) on the upfront $90 payment
until the debt is paid (assume $2 in this example);
- When
the $110 is collected from the client's customer, the
factor/discounter pays or makes available to the client
the $110 amount less the $90 upfront payment, the $1
administration fee and the $2 discount fee, i.e. $17.
Recourse and non-recourse arrangements
The distinction
between recourse and non-recourse arrangements is that
under the latter the factor/discounter acquires the debt
at its own credit risk. In practice, virtually all factoring/discounting
in Australia is conducted on a recourse basis, and these
arrangements generally operate along the following lines:
- the
assignor (client) and factor/discounter enter into
an agreement whereby, for the term of the agreement,
the assignor offers its debts that are due (or that
will become due) for sale to the factor/discounter;
- the factor/discounter
may have the discretion to accept or reject the offer;
- the
factor/discounter determines the availability for funding
based on the value of debts purchased and their classification
as approved or disapproved for funding. For example,
debts that are over 90 days old are commonly not eligible
for funding against.
- funding is then made available and
drawn by the assignor.
For factoring/discounting arrangements
(both recourse and non-recourse) the assignor will normally
be making a financial supply when it assigns the debt
(or part of it) to the factor/discounter.
The following frequently asked questions are addressed
below:
Q. What is Discounting?
A. Invoice discounting, which is commonly referred to
just as discounting, is simply turning your unpaid
invoices into cash. You literally sell your unpaid
invoices to the discounter.
Q. What is Factoring?
A. Factoring involves the sale of your
unpaid invoices as above, but in addition the sales accounting
functions are then provided by the factor, who manages
the sales ledger and collection of accounts.
Q. What is the difference between Factoring and Discounting?
A. Under both facilities you sell your
unpaid invoices for immediate access to cash, but under
a factoring arrangement the factor additionally manages
the sales ledger and collection of accounts. In essence,
factoring enables you to outsource the record-keeping
associated with the collection and management of your
sales invoices.
Q. Unpaid Invoices - A Problem or an Asset?
A. It is not unusual for a business
to regard unpaid invoices as a problem. But they are
an asset of the business, commonly one of its largest
assets, and just as commonly one of its most under-utilised.
With cash flow finance, the problem of unpaid invoices
can be turned into an asset - cash in the bank account!
Q. How does Factoring and Discounting help a business?
A. Cash flow finance provides immediate
funds for business growth and allows your management
to concentrate on the core activities of running the
business. By improving your cash flow you maintain control
over your business and can enjoy:
- Reduction in administration
overheads
- Increased sales
- Supplier discounts
- Increased profits
- Bigger orders by offering affordable
credit terms.
Q. Will my business qualify?
A. A key requirement to qualify for
cash flow finance is to ensure that your debtors' ledger
does not carry any unreasonable commercial risks. We
have a few guidelines to help us here:
- Invoices should
be for goods/services which have been fully delivered/completed.
(e.g. progress invoices on unfinished jobs would generally
not be acceptable.)
- If asked, your customer should be
able to confirm that the invoice is accurate and that
no dispute exists. You should be able to provide proof
of delivery of your goods and/or satisfactory completion
of services.
- Invoices which are older than 90 days (from
the end of the month in which they were issued) are
not usually eligible for financing.
- Extra care is needed
where any customer balance represents more than 20%
of your total debtors ledger. Generally, when one customer
exceeds 25% - 30% of the ledger, the level of normal
funding may be reduced.
Most businesses in many industries
easily qualify for cash flow finance.
Q. What about Start-Up Businesses?
A. Cash flow finance is able to assist new business ventures.
Ideally, your annual credit sales should be exceeding
$200,000 (or be able to reach this level in the short
term). Invoice discounting tends to be suited to more
established businesses.
Q. Do I need to provide Real Estate Security?
A. Cash flow finance is secured primarily by your debtors'
ledger. Real estate security is not required and this
is a major point of difference when making comparisons
with other types of finance.
Q. What are the costs?
A. Invoice Discounting - the discount
charge is typically calculated daily on the actual amount
of funds drawn from your facility, together with a management
fee calculated against the value of your invoices submitted
for discounting.
Factoring - in addition to the discount
charge, factoring involves an administration fee. The
administration fee is like an outsourcing cost for having
your debtor administration tasks handled in a professional
and time-efficient manner. Amongst other things the amount
of this fee will depend on the number of debtors and
invoices factored.
The factoring and discounting industry
in Australia is a very competitive market, and you should
obtain a number of quotes from IFD members.
Q. What does Outsourcing my Debtor Administrator mean?
A. The full debtor administration service
includes the preparation and mailing of monthly statements
to your customers, issuing reminder letters and follow-up
telephone calls (if necessary), the receipt and allocation
of customer payments, and the recording and resolution
of customer disputes.
Detailed reports are regularly
prepared for you by the factor, which keep you fully
informed on the status of your customer accounts.
The
investment in time and labour, which your business is
currently spending on these tasks, can be significantly
reduced.
Q. What will my customer think?
A. With invoice discounting your customers will not be
aware of any difference. Your invoices make no reference
to the discounting company and payments continue to
be made payable to you. You continue to be responsible
for the follow-up of customers for payment.
With factoring your interaction with your customers will
remain much as before. The factor's role is simply to
put the administrative side of your relationship on a
more professional footing to ensure there is a timely
follow-up of the customer for payment, and to properly
record payments received from customers.
Q. Is there a Minimum Period?
A. The period of the agreement varies
between cash flow financiers and you should establish
these conditions at the outset of the facility.
Q. Who sets Credit Limits?
A. The setting of customers credit limits is left entirely
to you. The factor/discounter will advise you when
it believes you are over extending credit to a specific
customer, and this is to assist you with your credit
control, and hopefully help you avoid unnecessary bad
debts.
Q. What about Bad Debts?
A. Cash flow finance is not a solution for your bad debts,
and you need to separately address this issue.
Q. What if I have more Technical Questions?
A. In conjunction with major accounting
firm KPMG, IFD has prepared a technical paper dealing
with the accounting treatment of factoring and discounting.
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