Invoice Discounting -versus- Debt Factoring

Debt Factoring v Invoice Discounting Q 3 (b) – June 2008

Debt Factoring

Definition: The outsourcing of your Credit Control Department for a fee => usually a % of Sales => if the fee is calculated on the top-line => then normally very expensive.

How is it offered to customers ?

Answer

There are 3 levels of service – each for a progressively higher fee.

• Administer Sales & Debtors Ledgers
– Administration of Sales and Debt Collection includes:
– Assess Customer Credit Worthiness
– Set Customer Credit Terms and Settlement Discounts
– Manage Customer Credit Control Systems
– No Bad Debt Insurance – the company retains responsibility for any bad debts.

• Advance Finance – with Recourse
– Advance, say, up to 80% of sales values immediately upon invoicing
– The company remains responsible for any Bad Debts, i.e. No Bad Debt Insurance

• Advance Finance – without Recourse
– As above (with recourse) but this time the factor accepts responsibility for any Bad
Debts , i.e. Bad Debt Insurance

Advantages of Debt Factoring

Things to watch out for when doing a Financial Analysis computional question ?

• Very efficient credit control system
• Loan is at a Competitive Interest Rate (normally)
• Helps company overcome temporary C/F shortage
• Reduces Administration Costs
• Reduces Administration Time – chasing Debtors, etc.,
• Helps company avail of Supplier Discounts
• Gearing Ratio – a source of finance that does not normally affect the gearing ratio

Disadvantages of Debt Factoring

Things to watch out for when doing a Financial Analysis computional question ?

• Non-Confidential – this is the biggest drawback.
• Expensive – can be very expensive. Remember, the fee is usually calculated as a % of sales
• “Lender of Last Resort” – customers often will view the use of a factor in a negative light – giving rise to image concerns. Therefore, the use of factor can damage your financial reputation.
• Aggressive Factors – can cost you customers if they are too strict on credit policies
• Conservative Factors can cost you customers – if they are overly cautious in extending credit -turning down potential customers who would normally be seen as an acceptable credit risk. Why? Because remember, they are the ones who stand to suffer any losses from bad debts.
• The Bank should be informed – which may cost you your overdraft !

Invoice Discounting – Question 3(b) – June 2008

Definition: Provide short term finance secured against individual high quality invoices. The Selling of an invoice(s) to a Third party (usually a Bank) for a lower (Discounted) amount.
Normally non-recourse – but here this is unimportant as the Invoice Discounter is very careful about the selection of the Debtors.

Advantages of Invoice Discounting

Things to watch out for when doing a Financial Analysis computational question ?

• Confidential service – this is its greatest advantage
• Company receives cash immediately sales is made / invoice raised or more importantly when it wishes to take remedial action in the face of an impending cash shortage.
• Without Recourse – normally Invoice Discounting is without recourse due to the high quality nature of the individual invoices / customers involved.

Disadvantages of Invoice Discounting

• Expensive – can be expensive. The fees involved depend on the quality of the underlying invoices / customers.

**** Make sure you LEARN – OFF this handout and practice all of Q3 June 2008 ****