Factoring in a cash flow spike
Factoring has suffered from image problems in the past, but can be a useful way for a business to help overcome a cash-flow squeeze.
In factoring and discounting, a business borrows against its unpaid invoices, so instead of waiting until the bills are paid, they get instant access to cash.
Lee Clarke, chairman of the Debtor and Invoice Finance Association, says factoring is useful for any company that has a working capital gap - that is, if invoices aren't being paid quickly enough to cover costs, which is often a problem for a growing company.
He offers an example of a labour hire company. If the company supplies staff it must pay weekly, but it gets paid only once a month by the company to which it supplies workers, it has a cash-flow shortage.
The company can get up to 80 per cent of the value of that invoice straight away with factoring, giving it the working capital to pay its staff and meet other obligations.
Factoring earned a bad reputation when it was introduced to Australia 30 years ago because it was seen as a lender of last resort.
Companies on their last legs would squeeze some cash out of their invoices to prop themselves up for a little longer and factoring became tarnished by the large number of collapses it was associated with.
The industry body changed its name from the Institute for Factors and Discounters of Australia and New Zealand this year, and Clarke says factors are more careful about who they lend to today.
"Where we did go wrong was providing finance to the wrong type of business," he says.
Factoring has been confused with debt collecting, but Clarke says it is a financing arrangement and factors keep the money they've collected, whereas debt collectors are collecting on another's behalf.
When factoring invoices fall into arrears, factors usually hand them over to debt collectors, he says.
Factoring remains a niche market, with 3000 firms using it so far in Australia.
Paul Dubois, associate director at professional services firm Hayes Knight, says factoring is useful for companies without access to traditional lenders, such as banks, or access to collateral.
It also lets other companies free up other capital which they could use for equipment or property financing, rather than tying it up in working capital.
"It allows the balance sheet to grow without tying up other forms of security," says Dubois, who advises clients on factoring but doesn't provide the service himself. "It doesn't turn out to be that much more expensive for the additional benefits you get out of it."
He says it's easier for companies to increase their borrowing limits with factors if their invoices are growing than it is with banks, which require expensive and time-consuming forecasts and accounts.
Factors usually charge an establishment fee and ongoing fees, consisting of a service fee for administering the facility and debt collection and an interest charge based on the amount borrowed.
Dubois says the higher charges are often worth the price to allow companies to free up other sources of funding. He also notes that the security taken by the factoring companies - unpaid invoices - isn't as safe as property collateral.
Clarke doesn't dispute estimates that the total cost of factoring in some cases can be as high as 18 per cent, but notes that this also includes the payment collection services. "You've got cost savings there because you don't have to pay for a full-time salary for an accounts receivable person," he says.
Factors and discounters will lend anything from about $20,000 up to - in theory - $250 million.
"To make it commercially viable for the customer and for the factor to make money, turnover needs to be in the vicinity of $250,000 per year," Clarke says .
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