Factoring: easing your cash flow by Audrey C. Welds
Source: Financial Gleaner, August 18, 2000
A tight cash flow is a common ailment of companies in business whether small, medium or large in size. One of the methods used by companies internationally and to some extent locally to ease the cash flow problem is factoring.
What is factoring?
Factoring may be defined as the purchase from a company of a part or the whole of its trade receivables. The purchase may be made with or without recourse to the company if in fact the receivables are unpaid by the relevant debtors of the company. In other words the company may agree to pay the purchaser of the receivables if the debtors fail to honour their obligations or it may not in which case the risk of non-payment passes completely to the purchaser (or factor).
It will be apparent that factoring assists the seller by providing immediately available cash when otherwise the seller company would have had to await payment of the receivables in the normal course of trade. Such cash could in certain instances determine whether it survives or fails and in the case of a small company where resources are often limited this is more likely to be the case.
In more sophisticated markets, a small company can also benefit from not having to maintain a sales ledger. Instead this burden is shifted to the factor leaving the seller company to concentrate on other areas of the business such as product development and marketing. In addition, because the factor is likely to be a fairly sophisticated financing entity with greater knowledge of the creditworthiness of various persons it can provide credit checking services to the seller company. If a factor refuses to buy a particular receivable, or to do so only if the seller company stands behind it, it is reasonable to assume that it does not consider the particular customer of the company to be a good credit risk.
International factoring
The use of factoring need not be limited to domestic transactions. In fact, factoring is also used by exporters and is particularly useful where the exporter is exporting goods to a country with which he has had no previous experience.
In an international factoring arrangement, the local exporter first reaches agreement in principle with the foreign importer for the sale of his goods to the importer. The exporter then makes contact with a local factor who he asks to purchase the receivable which will arise out of the sale. The local factor will in turn make contact with a foreign factor who gives to the local factor its opinion of the creditworthiness of the importer. Relying on that opinion, the local factor may purchase the receivables under a factoring arrangement. In this event, the foreign factor may play the role of a collection agent. However, it is possible for the transaction to be so structured that the foreign factor itself enters into the factoring transaction with the local exporter.
Of course, the sale of a receivable by a company takes place at a price which is lower than the amount of the receivable. How much lower it is will depend among other things on the degree of risk that the factor perceives to be involved.
Up to now, there appears to be only a small number of these transactions occurring in Jamaica. In contrast, in 1994 the United States saw a total of US$60,000,000,000 worth of factoring (by turnover). Comparative figures for the United Kingdom and Japan were US$40,000,000,000 plus and US$20,000,000,000 plus respectively. It would not be surprising if we were to follow this trend (although inevitably in a more modest way) when our economy turns around.
* Audrey C. welds is an attorney-at-law with Dunn, Cox, Orrett & Ashenheim.