Factoring is primarily used by smaller businesses to cover short term expenditures and liabilities. This typically includes firms with unpaid invoices and late debtors. Factoring in Nigeria is provided by few specialist firms regulated by the Central Bank of Nigeria.
What is Factoring?
Factoring is the management and purchase of business debt by a factor. it is the selling of trade debt for immediate cash by an exporter to a factor for a commission. Factoring enables a company to raise finance through the sale of book debts arising from a trade between itself and another party. It is one of the financial services now offered by many banks all over the world. Albeit through their associated companies. This has not been the case with Nigeria commercial banks but there is no doubt that with the recent equity participation allowed to banks in their corporate customers and more anticipated innovative developments in the banking industry before long. Banks will be more involved in factoring business debts as it is in other semi-developed and developed nations of the world.
Factoring is fast becoming recognized by companies as a way of controlling cash flow and improving credit management. Basically, factoring is most appropriate for exporters selling on open account basis and need involve nothing more than an arrangement with a relevant specialist company for supervising, insuring and collecting book debts leading to a way whereby the exporter is financed. Approved book debts are assigned at the invoice stage to the factoring company which collects the money in due course and pays it over to the customer or immediately buys over these book debts with or without recourse to the exporter. “with recourse” factoring finance is uncommon and while it is not impossible to have an undisclosed factoring relationship, most factoring houses will normally insist on their names being disclosed to the other party-the importer.
From the above analysis, there are two types of factoring;”with recourse factoring” and “without recourse factoring”. As regards with resource factoring, arrangement is made to purchase the customer’s debt on the basis that should the debtor become unable to pay the debt factored, the other maintains a right of recourse to its customer, the exporter. In effect, the customer has a contigent liability for eventual bad debts. On the other hand, without recourse factoring arises whenever such book debt are purchased by the factor with no right of recourse to its customer thereby, bearing any loss arising from the importer’s inability to make payments. The customer has no contigent liability or any future bad debts from the transaction.
Services offered by factoring agents
- Administrative services: the factor manages the sales ledger of the client i.e. the exporter. This will involve keeping of sales ledger, invoicing, debt collection as and when due and any other services which may relate to administration of the customer’s sales ledger which normally vary from one company to another. Thus, the exporter saves all associated administrative costs. Specifically, this service offers the exporter the following advantages
- Prompt invoicing
- Efficient maintenance of the company’s sales ledger
- Provision of better credit control
- Efficient debt collection
These advantages are derived from the fact that factoring companies normally operates on a large scale and for this reason enjoy economies of scale
- Credit protection: in Nigeria, bad debt has become a household word in the business circle. Financial institutions are no exceptions. It follows, therefore, that one of the problems of any business concerning today is the high incidence of bad debts. Factoring companies provide a means of eliminating or reducing these bad debts. With their information system of credit intelligence and ability to assess credit risks of a client’s customer and advise accordingly. They are well placed to offer this service more effectively and efficiently. The company customer replaces its various debtors with a single debtor, the factor. the extent of credit allowed by the client to its individual customers is approved by the factor. the factor also monitors the day-to-day operation of accounts of its client’s customer.
- Factor financing: this service involves the advancement of funds by a factor to the client against the debts which it has purchased. In this way, the customer turns a customer a future debt into immediate cash. The customer may be given up to 80% of the invoiced amount as soon as the invoice has been issued and received by the factor. in due course, when the debtor pays, the factor will receive this payment and reimburse itself handing over any balance to the company. Since every business concerned must earn returns to cover its expenses, factors charge interest on any fund advanced.
Advantages of Factoring
- Avoids administrative cost of book-keeping, invoicing, credit control, debt collection and other overhead expenses associated with sales ledger administration.
- Ensures better management and credit control because of the expertise with which the specialists involved handle these.
- Affords management more time to devote to production, sales, research and innovations since time is as scarce as any other resources and the sales ledger administration taken over by the factor means creating or enlarging management’s time resource.
- It ensures better and efficient budgetary control and cash flow since there is a steady inflow of sales proceeds and as such estimates can be made more accurately.
- Credit risks are better assessed and incidence of bad debt thus reduced since factors have facilities which are more sophisticated than those which their clients can employ for assessment.
- Leads to prompt payment of debts owed since the specialists involved can exert payment from debtors than it can do itself. As a result, this improve the business liquidity and hence the working capital.
- It eliminates bad debt losses for factored debts because of the involvement of more efficient and versed specialized personnel of a factoring company, most especially when funds are advanced without recourse.
- Interest on overdraft/loan is likely to be higher than commission on factoring and as a result, interest rate is saved..
- Since liquidity is improved with the immediate cash received from factors, there is more opportunity for taking up cash discounts from suppliers and thus improves earnings.
- Production against bad debts- As a result of the wide experience gained by factors in different industries, coupled with their thorough credit control and administration systems, they are able to reduce the incidence of bad debts which otherwise would have paralysed many business
- Flexibility- The customer does not have to incur financial charges except where necessary. Incidences of financial charges has stifled the cash flow potential of some companies and eventually weakened their operations. If the business is seasonal, he can call for advance payments at that stage, thereby reducing financial charges.
- Efficiency- Since the factor normally agrees to a shorter collection period than that granted by the business itself, there is an efficient debt collection result which has the effect of improving the cash flow position of the factored companies.
Disadvantages of Factoring
- Expensive for small companies which are in business of exporting because of the usual service fees payable which are not usually in proportion to level of operation and debts.
- The customer does not recover full value of debts because of the commission usually charged by a factor for the advancement of funds.
- The collapse of the factor’s business would adversely affect the client’s business and as a result, the fortune of his business depends indirectly on the fortune of the factor.
- Factoring is by no means cheap as the factored company has to pay for the credit control and accounting services it receives. However, with the advantages of good receivables management, a bank might even lend money on the basis of a property executed domiciliation of payments form.