IFD- FAQ

What is factoring and discounting?

Factoring and discounting involve the assignment of debts by a business (the assignor of the debts, usually referred to as the client) for consideration, generally on a continuing basis.

There are various ways the purchase transactions are structured. For example, the debt can be sold to the factor/discounter for a price that is less than the face value of the debt. In this case the factor/discounter pays the business up to 90% of the invoice value in cash and the balance, less fees, is paid to the business after a set period, or after the debt has been collected. Sometimes the debt is purchased for its full face value and then a prepayment of the amount owed is made based upon an agreed prepayment rate.

What is the difference between factoring and discounting?

Under both facilities the client sells the unpaid invoices for immediate access to cash, but under the factoring arrangement the factor additionally manages the client's sales ledger and collection of accounts. Therefore, under a factoring arrangement the debtor makes payments to the factor. Under discounting, the debtor nominally makes payments to the supplier; but as the debt is owned by the discounter, the supplier is collecting these debts on behalf of the discounter.

An example:

The client has a $110 debt;

The client sells the debt to a factor/discounter;

The factor/discounter makes a $90 upfront payment to the client;

The factor/discounter earns a $1 administration fee;

The factor/discounter also earns a discount fee (usually a daily charge based on usage, similar to interest) on the upfront $90 payment until the debt is paid (assume $2 in this example);

When the $110 is collected from the client's customer, the factor/discounter pays or makes available to the client the $110 amount less the $90 upfront payment, the $1 administration fee and the $2 discount fee, i.e. $17.

Recourse and non-recourse arrangements

The distinction between recourse and non-recourse arrangements is that under the latter the factor/discounter acquires the debt at its own credit risk. In practice, virtually all factoring/discounting in Australia is conducted on a recourse basis, and these arrangements generally operate along the following lines:

		the assignor (client) and factor/discounter enter into an agreement whereby, for the term of the agreement, the assignor offers its debts that are due (or that will become due) for sale to the factor/discounter;
		the factor/discounter may have the discretion to accept or reject the offer;
		the factor/discounter determines the availability for funding based on the value of debts purchased and their classification as approved or disapproved for funding. For example, debts that are over 90 days old are commonly not eligible for funding against.
		funding is then made available and drawn by the assignor.

For factoring/discounting arrangements (both recourse and non-recourse) the assignor will normally be making a financial supply when it assigns the debt (or part of it) to the factor/discounter.

The following frequently asked questions are addressed below

Q.	What is Discounting?
A.	Invoice discounting, which is commonly referred to just as discounting, is simply turning your unpaid invoices into cash. You literally sell your unpaid invoices to the discounter.

Q.	What is Factoring?
A.	Factoring involves the sale of your unpaid invoices as above, but in addition the sales accounting functions are then provided by the factor, who manages the sales ledger and collection of accounts.

Q.	What is the difference between Factoring and Discounting?
A.	Under both facilities you sell your unpaid invoices for immediate access to cash, but under a factoring arrangement the factor additionally manages the sales ledger and collection of accounts. In essence, factoring enables you to outsource the record-keeping associated with the collection and management of your sales invoices.

Q.	Unpaid Invoices - A Problem or an Asset?
A.	It is not unusual for a business to regard unpaid invoices as a problem. But they are an asset of the business, commonly one of its largest assets, and just as commonly one of its most under-utilised. With cash flow finance, the problem of unpaid invoices can be turned into an asset - cash in the bank account!

Q.	What is Discounting?
A.	Invoice discounting, which is commonly referred to just as discounting, is simply turning your unpaid invoices into cash. You literally sell your unpaid invoices to the discounter.

Q.	What is Factoring?
A.	Factoring involves the sale of your unpaid invoices as above, but in addition the sales accounting functions are then provided by the factor, who manages the sales ledger and collection of accounts.

Q.	What is the difference between Factoring and Discounting?
A.	Under both facilities you sell your unpaid invoices for immediate access to cash, but under a factoring arrangement the factor additionally manages the sales ledger and collection of accounts. In essence, factoring enables you to outsource the record-keeping associated with the collection and management of your sales invoices.

Q.	Unpaid Invoices - A Problem or an Asset?
A.	It is not unusual for a business to regard unpaid invoices as a problem. But they are an asset of the business, commonly one of its largest assets, and just as commonly one of its most under-utilised. With cash flow finance, the problem of unpaid invoices can be turned into an asset - cash in the bank account!

Q.	How does Factoring and Discounting help a business?
A.	Cash flow finance provides immediate funds for business growth and allows your management to concentrate on the core activities of running the business. By improving your cash flow you maintain control over your business and can enjoy: Reduction in administration overheads Increased sales Supplier discounts Increased profits Bigger orders by offering affordable credit terms.

Q.	Will my business qualify?
A.	A key requirement to qualify for cash flow finance is to ensure that your debtors' ledger does not carry any unreasonable commercial risks. We have a few guidelines to help us here:- o Invoices should be for goods/services which have been fully delivered/completed. (e.g. progress invoices on unfinished jobs would generally not be acceptable.) o If asked, your customer should be able to confirm that the invoice is accurate and that no dispute exists. You should be able to provide proof of delivery of your goods and/or satisfactory completion of services. o Invoices which are older than 90 days (from the end of the month in which they were issued) are not usually eligible for financing. o Extra care is needed where any customer balance represents more than 20% of your total debtors ledger. Generally, when one customer exceeds 25% - 30% of the ledger, the level of normal funding may be reduced. Most businesses in many industries easily qualify for cash flow finance.

Q.	What about Start-Up Businesses?
A.	Cash flow finance is able to assist new business ventures. Ideally, your annual credit sales should be exceeding $200,000 (or be able to reach this level in the short term). Invoice discounting tends to be suited to more established businesses.

Q.	Do I need to provide Real Estate Security?
A.	Cash flow finance is secured primarily by your debtors' ledger. Real estate security is not required and this is a major point of difference when making comparisons with other types of finance.

Q.	What are the costs?
A.	Invoice Discounting - the discount charge is typically calculated daily on the actual amount of funds drawn from your facility, together with a management fee calculated against the value of your invoices submitted for discounting. Factoring - in addition to the discount charge, factoring involves an administration fee. The administration fee is like an outsourcing cost for having your debtor administration tasks handled in a professional and time-efficient manner. Amongst other things the amount of this fee will depend on the number of debtors and invoices factored. The factoring and discounting industry in Australia is a very competitive market, and you should obtain a number of quotes from IFD members.

Q.	What does Outsourcing my Debtor Administrator mean?
A.	The full debtor administration service includes the preparation and mailing of monthly statements to your customers, issuing reminder letters and follow-up telephone calls (if necessary), the receipt and allocation of customer payments, and the recording and resolution of customer disputes. Detailed reports are regularly prepared for you by the factor, which keep you fully informed on the status of your customer accounts. The investment in time and labour, which your business is currently spending on these tasks, can be significantly reduced.

Q.	What will my customer think?
A.	With invoice discounting your customers will not be aware of any difference. Your invoices make no reference to the discounting company and payments continue to be made payable to you. You continue to be responsible for the follow-up of customers for payment. With factoring your interaction with your customers will remain much as before. The factor's role is simply to put the administrative side of your relationship on a more professional footing to ensure there is a timely follow-up of the customer for payment, and to properly record payments received from customers.

Q.	Is there a Minimum Period?
A.	The period of the agreement varies between cash flow financiers and you should establish these conditions at the outset of the facility.

Q.	Who sets Credit Limits?
A.	The setting of customers credit limits is left entirely to you. The factor/discounter will advise you when it believes you are over extending credit to a specific customer, and this is to assist you with your credit control, and hopefully help you avoid unnecessary bad debts.

Q.	What about Bad Debts?
A.	Cash flow finance is not a solution for your bad debts, and you need to separately address this issue.

Q.	What if I have more Technical Questions?
A.	In conjunction with major accounting firm KPMG, IFD has prepared a technical paper dealing with the accounting treatment of factoring and discounting. This is available on our website: english37.ru.