The main services are described below using ‘traditional’ factoring industry terminology which the majority of factors still use, and in any event, will all recognise. It should be noted that services may differ slightly between factors
Services provided by factors are many and varied. The basic ingredients for these services are as follows:
- with or without bad debt protection (recourse or non-recourse);
- with or without disclosure to customers (non-confidential or confidential);
- where collection of debts is undertaken by the factor or by the client on behalf of the factor;
- agreements which provide for the assignment of all debts as they arise (whole turnover) or which provide for each debt to be offered to the factor .
The situation is further complicated by inconsistency in the labelling used by factors for their various types of services.
THE FULL SERVICE
Probably the most common form of factoring (in terms of client numbers) is the ‘full service’ arrangement whereby the factor, as part of a continuous cycle, agrees to purchase the invoices of the client as they arise in the normal course of trading. In addition to purchasing the debts, the factor will also administer and control the client’s sales ledger and collect due debts from the client’s customers. The factor will also provide regular and detailed documentation detailing receipt of invoices from the client, advances, payments by the customer, and other reports relating to sales ledger activity.
There are basically two types of full service arrangement:
- Recourse – whereby the factor does not provide protection against bad debts. In the event of a bad debt (or possibly before, depending on the age of the debt) the factor will recover from the client’s account moneys advanced against the debt.
- Non-recourse – whereby the factor absorbs losses incurred by a customer’s inability to pay. Also known as ‘bad debt protection’. The factor will usually set credit limits for customers and sometimes expect the client to absorb some of any loss.
The smaller independent factors, whilst not always offering non-recourse arrangements,
This is sometimes known as bulk factoring. Here, the arrangement still requires that the debtors be informed that all payments go to the factor but the client takes responsibility for the collection of debts, effectively acting as agent for the factor.
The arrangement is usually with full recourse and is purely for financing the trade credit requirements of the client’s debtors. The service is similar to invoice discounting and is appropriate where the client’s sales ledger operation is well managed and there is a large number of, usually small, accounts.
Often the client would either not be well established and/or too small for an invoice discounting arrangement, or where full factoring would be prohibitively expensive because of a large number of low value debts.
Invoice discounting is provided for clients requiring finance but not sales ledger administration or credit protection. The service is an increasingly popular choice among larger businesses (typically of turnover £400k). The client is not required to notify his debtors to pay direct to the factor (hence it is sometimes known as ‘confidential factoring’) and the debts are normally subject to full recourse. This is a purely financial service whereby the client maintains the sales ledger and collects from debtors on behalf of the factor to whom the debts have been assigned. The client, on collection of debts, pays the proceeds into the factor’s bank account. This form of factoring is more often provided by the larger factoring companies because of the greater sums involved.
Some factors will accept the purchase of debts for goods or services to foreign customers. In this situation the factor will usually employ a correspondent in the country of the importer to manage the collection and cover the credit risk.
There are a number of other forms of receivables finance services available which are sometimes referred to as factoring. Most are slight variations of the main services above, while others are a combination of receivables finance and other forms of asset finance.
ASSET BASED LENDING
Asset based lending is a form of funding which operates in a similar manner to factoring. However, in addition to funding against trade debts, other assets can be taken into consideration such as stock and property. This variant of factoring was developed in the US and has begun to be used in the UK in the last five years. Firms that offer this type of service avoid use of the term ‘factoring’.
Because other assets apart from trade debts are taken into consideration, the amount of funding available is often increased. As such, factors offering this service often advertise 100% or more funding against debtors.
MERCHANT TRADE FINANCE
Strictly speaking this is not factoring (by traditional definitions), although it is a form of debtor finance. Its operation is similar to that of factoring.
In merchant trade finance, the client sells his product to the merchant trader who then sells it to the client’s customer. The client at the same time delivers the product to the customer, effectively acting as agent for the merchant trader. The merchant trader pays the client up to 80% of the invoice value and the balance less charges on payment by the customer.
Although generally more expensive than factoring, merchant trading does not usually require that all of the client’s invoices are sold. Another advantage is that it does not affect any existing charge over book debts, which in the case of factoring would normally have to be waived in favour of the factor.